Marketing Intangibles A Critical Analysis of the Transfer Pricing Debate
Ajit Kumar Jain
Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ About the Author Ajit is a Chartered Accountant and Company Secretary from Mumbai. He has done his graduation from Jai Narayan Vyas University, Jodhpur. He has also been awarded certificates in International Taxation and Transfer Pricing by the Chartered Institute of Taxation, UK. Ajit is currently working with the Transfer Pricing practice of Deloitte Haskins & Sells LLP, Mumbai.
Contact Details Address:
101 Sai Mahal CHS, Nadiyaadwala Colony Road No.2, S.V. Road, Malad (West) Mumbai -400064
Phone :
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Email
[email protected]
Word Count Pages 35 Words 9,985 Paragraph 377 Lines 1,475 Including textboxes, footnotes and end note
Disclaimer: The views expressed in this document are not intended to be used as professional advice and also, represent only the personal views of the author.
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Table of Contents 1. Introduction………………………………………………………………………… 4 1.1. Background……………………………………………………………………… 4 1.2. Meaning of Marketing Intangibles…………………………………………........ 5 1.3. Ownership of Intangibles………………………………………………………... 6 1.4. The Issue of marketing Intangibles……………………………………………… 8 1.5. The Debatable Issues……………………………………………………………. 10 2. Available Guidance on the Issue………………………………………………….. 12 2.1 OECD’s Guidance………………………………………………………………. 12 2.2 ATO’s Guidance……………………………………………………………….... 13 2.3 Indian Transfer Pricing Regulations…………………………………………….. 14 3. Judicial Precedents on the Issue of Marketing Intangibles……………………... 15 3.1 Glimpse of the Litigation So Far………………………………………………... 15 3.2 Key Judicial Pronouncements…………………………………………………... 15 4. Evaluation of Debatable Questions……………………………………………….. 22 4.1 AMP as an International Transaction…………………………………………… 22 4.2 Economic Ownership…………………………………………………………… 25 4.3 Benchmarking of AMP Expenses………………………………………………. 27 4.4 Application in case of manufacturers…………………………………………… 29 5. Case Studies………………………………………………………………………... 31 5.1 Normal Distributor…………………………………………………………….... 31 5.2 Limited Risk Distributor………………………………………………………... 32 5.3 Licensed Manufacturer…………………………………………………………..33 6. Conclusion and Way forward…………………………………………………….. 33 Bibliography…………………………………………………………………………….35
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Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
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1. Introduction 1.1 Background In the past two decades, with the development of information technologies and efficient communication system, the countries across the globe became interdependent. As a consequence, the multinational enterprises established integrated supply chain models. This has led to increase in the cross-border transactions between affiliate entities located in different jurisdictions. Such transactions give opportunity to the multinational enterprises to shift profits from one jurisdiction to another jurisdiction, since profit shifting may be favorable for the entity located in the high tax jurisdiction. Any shifting of profit leads to a loss of tax revenue to the country from where profit is shifted. In last one decade, transfer pricing has gained a lot of importance and many countries introduced transfer pricing regulations to avoid shifting of profits and to safeguard the tax base or tax revenue. In India, the transfer pricing regulations were introduced in the year 2001, since then the authorities have been aggressive in scrutinizing the cross-border affiliated transactions. The Indian transfer pricing has evolved over the period of years. The initial years of transfer pricing scrutiny have seen significant focus and litigation relating to comparables for determining Arm’s Length Price (‘ALP’). There has been a gradual shift in focus of the tax authorities which is evident from their approach in the recently concluded assessments. The tax authorities now focusing on more niche transactions such as intangibles, location savings, business restructuring etc. Intangible is one of the niche areas wherein tax authorities have been very aggressive in scrutinizing arrangement to see if there are any transfer of intangibles or development of intangibles and whether the provisions of the arm’s length principles have been applied on the same or not. In this paper, the author has dealt with one of the key the transfer pricing disputes in the area of intangibles viz. issue of marketing intangibles. The issue of marketing intangibles had originated outside India. In India, the issue of marketing intangibles became the one of burning transfer pricing issues and involved a significant amount of transfer pricing adjustments. The issue has now reached at the Supreme Court level. Early this year, the Delhi High Court has pronounced a landmark ruling and laid down various principles to deal with this issue. This paper intends to explore the issue of marketing intangibles and to evaluate the open and debatable questions in light of the available guidance and principles laid down by the various judicial precedents.
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Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ 1.2 Meaning of Marketing Intangibles Intangibles include intellectual property (‘IP’) such as patents, copyrights, trademarks, service marks, trade names and trade secrets. IP normally indicates properties since the owner has the legal rights to exploiting them. However, in today’s commercial world, intangibles could encompass business models, propriety procedures, processes, know-how, customer relationships, supplier relationship management systems, marketing systems, information technology and many other categories of intangibles that bring value to the company. The Organization of Economic Corporation and Development (‘OECD’) has recently issued its final Base Erosion and Profit Shifting (‘BEPS’) report on ‘Aligning Transfer Pricing Outcome with Value Creation’. The report prescribes the definitions1 of intangibles and marketing intangibles as follows: Intangibles2 ‘Intangible’ is intended to address something which is not a physical asset or a financial asset, which is capable of being owned or controlled for use in commercial activities, and whose use or transfer would be compensated had it occurred in a transaction between independent parties in comparable circumstances. Marketing Intangibles3 “An intangible (within the meaning of paragraph 6.6) that relates to marketing activities, aids in the commercial exploitation of a product or service, and/or has an important promotional value for the product concerned. Depending on the context, marketing intangibles may include, for example, trademarks, trade names, customer lists, customer relationships, and proprietary market and customer data that is used or aids in marketing and selling goods or services to customers.” The above definition is the new definition of marketing intangibles prescribed by the OECD in its BEPS report. Here, it would be also important to look at the following earlier definition of the marketing intangibles as prescribed by the OECD in its Transfer Pricing Guidelines.
1
This are the new definitions as compared to the definition provided in the OECD transfer pricing guidelines [2010] Paragraph 6.6 of the OECD’s report on BEPS 3 Glossary of the OECD’s report on BEPS 2
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______________________________________________________________________ An intangible that is concerned with marketing activities, which aids in the commercial exploitation of a product or service and/or has an important promotional value for the product concerned We can observe that the new definition has widened the scope of ‘marketing intangibles’ since it provides illustrative examples in relation to type of marketing intangibles such as customer lists, customer relationships, and proprietary market and customer data as marketing intangibles. The illustrations are critical for ‘Multinational Enterprises’ (‘MNE’) groups operating in developing markets since these markets have very large consumer bases that may give rise to significant amounts of consumer-related data, which may be treated by the tax authorities as marketing intangibles. Thus, marketing intangibles may include any kind of intellectual property which indicates the origin of the product or service, promotes the marketing, sale or advertising, and adds value to the business itself. Marketing intangibles are a result of extensive marketing campaigns and efforts made to promote and sell products or services.
1.3 Ownership of Intangibles Ownership of intangibles is very crucial, since the returns related to intangibles depend upon the types of ownerships. Before discussing the issue of marketing intangibles, it would be important to evaluate and understand the ownership of intangibles. In the modern global world, the MNEs are not restricting the use their intangible to one region or country where the intangibles are initially developed. In order to remain in the competition, it is utmost important for MNEs to grant licenses of their intangibles to its various affiliates in the different territories of the world for exploitation, enhance and further development of intangibles to achieve growth and development in business. In the current scenario, intangibles are being developed by one enterprise (licensor) and the benefit of the same reaped by various affiliated entities (licensee) across the globe by bearing the risk and costs related to such intangibles. The licensee also makes efforts in the enhancement and development of intangibles or creating new intangibles. In general, there are two types of ownership for intangibles viz. legal ownership and economic ownership.
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Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ Legal Ownership The legal owner of intangibles is the recognized owner in law through legal registration. Thus, legal ownership can be obtained through legal registration of intangibles. Para 6.37 of the OECD’s BEPS report on ‘Aligning Transfer Pricing Outcome with Value Creation’ stipulates as under: Generally, the registered legal owner of such intangibles has the exclusive legal and commercial right to use the intangible, as well as the right to prevent others from using or otherwise infringing the intangible. These rights may be granted for a specific geographic area and/or for a specific period of time. In view of the above, the legal protection resulting from the legal title is the essential factor when determining legal ownership. The legal ownership brings prerogatives of control legal rights to deter competition through infringement. Economic Ownership Economic ownership is based on the business & economic realities and attached to the functions performed and risk assumed by the entity while development of intangibles. The economic owner is entitled to the income attributable to the intangibles further developed by it through additional efforts. Economic ownership has not specifically defined the OECD’s Transfer Pricing guidelines or report on BEPS. Economic ownership is subject to the economic conditions surrounding the intangibles. If any licensee makes considerable investment and assumes related risks this might create intangibles and the licensee accordingly avails right to exploit the intangibles as an economic owner. The United Nation’s Practical Manual on Transfer Pricing discusses the concept in Chapter 54 and states that economic ownership of a product trademark or trade name considering the marketing intangible can be created based on the subsidiary’s contribution to a strategy to enhance market share.
4
Para 5.3.2.15 of the Transfer Pricing Manual
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Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ The HM Revenue and Customs (‘HMRC’) 5UK defines economic ownership as under: “A person who has rights over intellectual property, such that he can exploit and develop and use it in a way that a legal owner may, but who does not have legal title, enjoys economic ownership.” Based on the above, we can conclude that the economic owner is financially responsible for the development and maintenance of intangibles in its market and is entirely entitled to the residual profit/loss generated by the exploitation of intangibles.
1.4 The Issue of marketing intangibles Subsidiaries of foreign MNCs, selling products in India under license to use the trademarks or brands of the foreign group companies, being the legal owners of such trademarks or brands, are facing litigation in India. The Indian tax authorities, as a general rule, seek reimbursement for the alleged excess Advertisement Marketing and Promotion (‘AMP’) expenses on the premise that such expenses create marketing intangibles, which benefit the legal owner of the brand and not the local Indian entity. Such excess is determined with reference to the AMP spend, as a percentage of turnover of the taxpayer, as compared to comparable companies selected to benchmark the results of the Indian taxpayer in its dealings with its foreign group entities. The level of AMP expenses incurred by such comparable companies is termed as the “bright line” and anything in excess is termed as non-routine expenses, which the Indian tax authorities assert that the same needs to be recovered from the legal owner of the brand with a mark-up. The issue of marketing intangibles was originated in the case of DHL Corporation in the United States wherein the court upheld the transfer pricing adjustment on account of marketing intangibles by applying the ‘Bright line Test’(‘BLT’). In India, the issue came up for considerations before the Delhi High Court in case of Maruti Suzuki India Ltd in the year 2010. The application of BLT is explained by way of following illustration:
5
HMRC, INTM464070- Transfer pricing: Types of transactions, who owns the intangible property?
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A Inc. USA
Outside India In India
B Limited
Facts -
A Inc. is engaged in manufacturing and distribution of consumer products. A Ltd. is the legal owner of all the IPs of its business. A Ltd. grants license to B Ltd., (a wholly owned Indian subsidiary of A Ltd.) for distributing finished goods in India.
-
B Ltd. has the distribution network in India to distribute the products of A Inc. in India
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B Ltd. incurs AMP expenses in India for the promotion of the products. The AMP expenses to Sales ratio of B Ltd. is 15%.
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The average AMP to Sales ratio of third party distribution companies is 5%
Application of BLT by the Tax Authorities -
The tax authorities have applied BLT and contended that B Ltd. has incurred a significant non-routine AMP expenses (comparing with the AMP ratio of B Ltd. with the AMP ratio of third party companies engaged in similar business/industry)
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The tax authorities contended that B Ltd. has rendered services to A Ltd. by contributing to the brand promotion of the products owned by A Ltd. Accordingly, B Ltd. should get compensation from A Ltd. for the excess or non-routine AMP expenses along with a service mark-up.
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The tax authorities applied BLT and made transfer pricing adjustment to the income of the B Ltd. in following manner (illustration):
Particular Sales revenue of B Ltd.
(A)
Amounts in INR 1,000
AMP expenses incurred by B Ltd.
(B)
150
(C)= B/A (D)
15% 5%
(E)= C-D (F)= A*E (G)= F*10% F+G
10% 100 10 110
AMP to sales ratio of B Ltd. Average AMP to sales ratio of the comparable companies Non-routine AMP expenses incurred by B Ltd Compensation to be received by B Ltd. from A Ltd. Service Mark-up @10%6 Adjustment to the income of B Ltd
Based on the above working, the tax authorities proposed an adjustment of INR 110 to the income of B Ltd. on account of brand building services rendered by B Ltd. In applying the BLT, the tax authorities considered the similar comparables selected for benchmarking routine transactions, i.e. import, export etc. and no separate comparability analysis performed for benchmarking the AMP expenses.
1.5 The Debatable Issues The issue of marketing intangibles is based on various presumptions. The issue is one concerning the fundamentals of economics and is highly factual in nature. Therefore, it requires an in-depth factual analysis, The issue has been debated both from legal and factual perspective. On a macro level, there is one key debatable issue viz. whether the taxpayer has actually rendered any service to its Associated Enterprise (‘AE’) by incurring AMP expenses in the local market and whether AMP expenses can be considered as international transaction. However, apart from these, there are many other issues which also have been largely debated and litigated in India in the last couple of years. The key debatable issues in the whole litigation of marketing intangibles are as follows:
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Based on a separate comparability analysis
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Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
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Debatable Issues
Details
1
International Transaction
- Whether the AMP expenditure is an international transaction under Indian Transfer Pricing Regulations
2
Ownership of marketing intangibles
- Whether the concept of economic ownership exist in real sense
3
Economic analysis
- How to perform economic analysis for the AMP transaction
Applicability to manufacturers
- Whether AMP expenses can be aggregated with other international transactions Whether the principles of Delhi High Court ruling equally applicable in case of manufacturers
4
Before separately evaluating each of the above issues, it is crucial to understand the available guidance and the outcome of the various judicial precedents in India on this whole debate of marketing intangibles.
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2. Available guidance on the issue 2.1 OECD’s Guidance The OECD’s recent BEPS report on ‘Aligning Transfer Pricing Outcome with Value Creation’ stipulates guidance related to the issue of marketing intangibles. The guidance addresses7 issue of marketing activities undertaken by an enterprise not owning the trademark by responding the following question: “Whether a marketer/distributor should be compensated only for providing promotional and distribution services or the marketer/distributor should also be compensated for enhancing the value of the trademarks and other marketing intangibles by virtue of its functions performed, assets used and risk assumed. The OECD’s BEPS report8 prescribes that the analysis of the marketing issue requires assessment of following: (i) The obligations and rights implied by the legal registrations and agreements between the parties; (ii) The functions performed, the assets used, and the risks assumed by the parties; (iii) The intangible value anticipated to be created through the marketer/distributor’s activities; and (iv) The compensation provided for the functions performed by the marketer/distributor (taking into account of the assets used and risks assumed). Based on the above guidance, obligation, conduct and the characterization of the party are the key elements which determine whether a separate compensation for AMP expenses shall be required or not. If the distributor merely acting as an independent agent there may not be any issue pertaining to the marketing intangibles, since the distributor is entitled to a compensation for all the AMP expenditure it has incurred from the owner of the brand. On the other hand, when the distributor actually bears the cost of marketing activities (i.e., there is no arrangement for the owner to reimburse the marketing expenditure), the issue is to find out
7 8
Para 6.76 to 6.78 of the BEPS report Para 6.77 of the BEPS report
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______________________________________________________________________ to what extent the distributor is contributing in the brand owned by its parent entity by functions performed, assets used and risk assumed currently or in future. In general, the party that is not the legal owner of the trademark or marketing intangible, to obtain any benefit (compensation for marketing efforts) of marketing intangibles will depend upon the substance of the rights and obligation of that party. An independent comparable analysis should also be required to find out whether the distributor is entitled for any compensation for its marketing efforts. Further, the OECD’s report on BEPS suggests that any compensation to the distributor (compensating for its functions, assets, risks, and anticipated value creation) could take the form of higher distribution profits resulting from: -
A decrease in the purchase price of the product); or A reduction in royalty rate ; or A share of the profits associated with the enhanced value of the trademark; or Other marketing intangibles
The OECD’s guidance brings clarity on various aspects (i.e. need for compensation, methodology for compensating distributor for the marketing efforts, etc.) for dealing with the issue of marketing intangibles. The key question that needs to be raised and answered in the context of marketing intangibles is whether the licensee of the brand had incurred the AMP expenses in the capacity of a service provider or on its own account as an entrepreneur. For analyzing the whole issue, the OECD has given emphasis on assessing the rights, obligations and conduct of parties by performing a detailed Functions, Assets and Risk (‘FAR’) analysis. 2.2 ATO’s Guidance The Guidelines issued by the Australian Tax Office (ATO) on marketing intangibles discuss the issue of marketing spend in the context of a distributor and not a manufacturer. The ATO’s guidance is in line with the principles laid down by the OECD. The ATO guidelines referred various examples which have given emphasis on the following required elements for the arm’s length treatment of the AMP expenses: -
The contractual arrangements between the owner of the trade name and the market;
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Whether the level of marketing activities performed by the marketer exceeds that performed by comparable independent enterprises;
-
The extent to which the marketing activities would be expected to benefit the owner of the trade name and/or the marketer; and
-
Whether the marketer is properly compensated for its marketing activities by a ‘normal’ return on those activities or should share in an additional return on the trade name.
2.3 Indian Transfer Pricing Regulations Although the issue marketing intangibles is the most contentious transfer pricing issue in India, the Indian Transfer Pricing regulations do not specifically provide any guidance to deal with this issue. Here, it is worthwhile to mention that various Indian judicial precedents have dealt with this issue in detailed and provided guidance. The author has discussed the same in Section 3 below.
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3. Judicial Precedents on the Issue of Marketing Intangibles 3.1 Glimpse of Litigation So Far In India, the issue of marketing intangibles came up for consideration before the Delhi High Court in the year 2010 in case of Maruti Suzuki India Limited. Thereafter, the issue has been largely debated and litigated at various Tax Tribunals and also at High Court in India. It would be worthwhile to have a glimpse of the litigation in India on marketing intangibles in a timeline frame as given in the below diagram:
The facts and the outcome of the key rulings are mentioned in the table below: 3.2 Key Judicial Pronouncements The issue of marketing intangibles was initially dealt in the case of Maruti Suzuki in the year 2010, however, the detailed guidance on this issue has been provided by Special Bench (‘SB’) ruling in case of LG Electronics in the year 2013. This ruling was not favorable to the taxpayers, however, it has touched upon each and every aspect of the whole litigation. Early this year, the Delhi High Court (‘HC’) has pronounced a landmark judgment in the case of Sony Ericsson Mobile Communication India Private Limited and various other taxpayers (engaged in distribution business) on the issue of marketing intangibles. The Delhi HC ruling was the major relief for the taxpayer since the HC has ruled out the applicability of BLT for computing the ALP of AMP expenses and provided detailed guidance Page | 15
Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ for computing the ALP of AMP expenses as per the provisions of the Indian Transfer Pricing regulations. The brief facts and outcome of the key judicial pronouncements are mentioned in the table below: Name of Ruling US Tax Court Case – DHL Inc.
Brief Facts - DHL Corporation (DHL) and its foreign affiliates were involved in the worldwide package delivery business - DHL licensed the trademark to DHLI, Hong Kong - During the year under consideration, a Japanese company agreed to purchase the DHLI, Hong Kong stock
Key Outcomes Propounded the ‘Bright Line Test’ for distinguishing between the routine and non-routine expenditure AMP expenses to the extent incurred by the uncontrolled comparable distributors is to be regarded with the ‘Bright Line Limit’ It was held that beyond this limit, the expenses constituted non- routine expenditure and resulted in the creation of economic ownership
- While adjudicated on the consideration for this deal, the tax court coined BLT in determining the presence of any marketing intangibles created by DHLI, Hong Kong - The issue arose on account of the 1968 US Regulations, which promoted the theory related to “developer-assister rules”. Under those rules, the developer – being the licensee incurring the AMP expense was treated as an economic owner of the brand, and the assister – being the legal owner of the brand.
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______________________________________________________________________ Name of Ruling Brief Facts Key Outcomes - The taxpayer manufactures cars - If AMP spend is more than incurred by Delhi High Court- Maruti as well as trades spares & comparable enterprise, owner of the IP Suzuki India components needs to compensate licensee Limited - The taxpayer entered into a - AMP spend may have benefited Indian license agreement with Suzuki company because it had the continued Motor Corporation for use of use of the “Suzuki” brand name. Benefit technology and trademark to Suzuki may be incidental
Delhi Tribunal – [Special Bench]LG Electronics India Private Limited
- The taxpayer has used ‘S’ logo - Return for AMP activities can also in (‘Suzuki’) on the front of the the form of higher turnover cars, though it continues to use trademark ‘Maruti-Suzuki’ on the - Following this observation of the case, rear side of vehicles. the Supreme Court directed the transfer pricing officer to reexamine the matter - The tax authorities have raised in accordance with law, without being the issue of marketing intangibles influenced by the observations or by contending that the taxpayer directions given by the High Court have incurred excessive AMP expenses. - The taxpayer is a wholly owned - AMP is an international transaction subsidiary of LG Electronics (provision of service) between the Inc., Korea taxpayer and the AE since the taxpayer has incurred AMP expenses for the brand promotion of AE - As per the royalty agreement between the taxpayer and LG Inc., Taxpayer was given the - Legal ownership is relevant under the right to use the technology Income Tax Law; economic ownership owned by LG Inc. for exist only in a commercial sense manufacturing LG’s products in India - BLT is a valid method in order to determine the transaction value of - The taxpayer is characterized as AMP a licensed manufacturer in India - The SB has laid down certain factors/ principles (14 questions) which are said to have considerable bearing on the question of determination of cost/value of the international transaction of brand promotion through AMP expenses incurred by the Indian company for its AE
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______________________________________________________________________ Name of Ruling Brief Facts Key Outcomes The questions are mainly pertaining to characterization of taxpayer & AE, royalty payment, details of the brand in India (newly launched or established), termination clause in agreement, any existing arrangement between the taxpayer and AE in relation to compensation for non-routine AMP expenses etc.
Delhi TribunalBMW India Private Limited
-
Selling and distribution expenses (discounts, commission, sample expenses, trade incentives, etc.) do not form a part of the AMP expenses and hence, these expenses cannot be considered while computing the bright line test
-
Limited discussions in the ruling on the characterization of the taxpayer
-
If Taxpayer has incurred “non-routine” AMP expenses, then it is appropriate to re-characterize the transaction to separate transaction of brand building of the foreign AE
-
The taxpayer is a distributor of motor vehicles in India
-
Imports vehicles from AE and sales in India
-
The taxpayer entered into ‘importation agreement with its parent company In the transfer pricing documentation, the taxpayer characterized itself as a distributor -
The taxpayer performed more functions than a normal distributor
-
No compensation required from AE as the same has been received by way of
-
AMP activities of the taxpayer contributed in the brand development of the AE Brand building by AE is an international transaction and bright line is an accepted method for calculating no-routine AMP expenses
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______________________________________________________________________ Name of Ruling Brief Facts Key Outcomes premium profits
Delhi High Court RulingSony Ericsson Mobile Communication India Private Limited other taxpayers9
-
The premium profits earned by distributor are adequate compensation for excess AMP
The Delhi HC in a landmark judgment in the case of Sony Ericsson Mobile Communication India Private Limited vs. CIT and various other taxpayers (engaged in distribution business), pronounced its ruling on the issue of marketing intangibles. It was a landmark ruling since it has provided detailed guidance to deal with the issue.
The HC held that the declared price of international transactions included the remuneration for their AMP function and accordingly upheld view of the SB in LG case and held that AMP expenditure amount to an international transaction
-
The HC held that the fundamental part of the analysis is to find out the characterization of the entity which has incurred a non-routine or excessive AMP expenses.
-
It has held that once the Transfer Pricing Officer accepts and adopts the Transactional Net Margin Method (‘TNMM’) and then chooses to treat a particular expenditure like an AMP as a separate international transaction without bifurcation/segregation, it would lead to unusual and incongruous results
-
The HC has upheld that the economic owner must be adequately compensated for its economic
In a situation where multiple transactions are so interlinked that they cannot be evaluated on a separate basis, aggregation of transaction is both desirable.
9
There were 17 connected matters related to several taxpayers including appeals and cross appeals filed by the taxpayers and by tax authorities
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______________________________________________________________________ Name of Ruling Brief Facts Key Outcomes ownership in event of alienation of intangibles. Economic ownership when pleaded can be accepted if it is proved by the taxpayer
Delhi Tribunal Perfetti Van Melle India Private Limited
-
The HC held that there was nothing in the Act or Rules to hold that it was obligatory for the AMP expenses to be subject to ‘Bright Line Test’ and the non-routine AMP expenses as separate as a separate international transaction.
-
The Court has granted relief to the taxpayers by holding that if aggregated transaction is concluded to be at ALP by applying TNMM or RPM, there is no need to bifurcate and treat AMP expense as a separate international transaction
-
The HC has held that direct marketing and sales related expenses are not directly linked to brand building, but have a direct and immediate connect with increased sales The Tribunal held that that relevant parts of the HC judgment will be applicable to both manufacturers and distributors
-
The taxpayer is engaged in the manufacturing of confectionery products at various factories in India
-
The tax authorities held that the taxpayer has incurred excessive AMP expenditure without charging any compensation for rendering the brand/trademarks promotion service
It further clarified that in case of a manufacturer, the international transactions concerned with the manufacturing activity cannot be aggregated with the AMP activities, as both are separate and distinct
-
The key question was whether the ratio of the Delhi HC ruling shall equally apply to manufactures as well
The case would also be applicable to a service provider that uses the brand/trademark/trade name owned Page | 20
Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ Name of Ruling Brief Facts Key Outcomes by a foreign related party while rendering services to third parties
The Delhi HC ruling was a welcome ruling for the taxpayers, since it has cleared various ambiguities of the whole issue by providing detailed guidance on the transfer pricing treatment of the non-routine AMP expenses. However, there are still few open questions on which further debate is possible, e.g. (i) Whether AMP expenses can be considered as international transaction in every scenario in which licensor and licensee operate (ii) whether the guidance or ratio of the HC ruling is equally applicable in case of licensed manufactures. In the next Section of this Paper, the author has evaluated the key debatable points pertaining to the whole issue of marketing intangibles.
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4. Evaluation of Debatable Questions 4.1 AMP as an International Transaction The taxpayer contended that, there was an absence of any understanding, whether oral or written, between the taxpayer and its AE, hence was no transaction of creating marketing intangibles. The taxpayer also contended that all of the AMP expenditure incurred was for its own business purposes. In this regard, it is important to evaluate the relevant provisions of the Indian Transfer Pricing regulations. The meaning of ‘International transactions’ and ‘Transaction’ is provided in Section 92B of the Income Tax Act, 1961 (‘the Act’). The text of the provision is under: Section 92B: Meaning of International transaction (1) For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. (2) ……………………………………. Section 92F: Meaning of transaction (v) “transaction” includes an arrangement, understanding or action in concert,— (A) whether or not such arrangement, understanding or action is formal or in writing; or (B) whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding
From the conjoint reading of the provisions of clause (v) of section 92F and sub-section (1) of section 92B of the Act it could be inferred that transfer pricing regulation would be applicable to any “transaction”, being an arrangement, understanding or action in concert, inter alia, in the nature of purchase, sale or lease of tangible or intangible property or any other transaction having bearing on profits, income, losses or assets of such enterprises. Therefore, in order to be characterized as an ‘international transaction’, it would have to be demonstrated that the same arises pursuant to an arrangement, understanding or action in concert.
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______________________________________________________________________ Further, up to 2012, the definition of an international transaction did not expressly refers to transactions in respect of brand development or brand building services. However, the term “international transaction” includes a transaction in respect of the provision of services between two or more AEs. In 2012, the Indian Govt. has expanded the definition of “international transaction” with retroactive effect from 1 April 2002 to include a transaction in respect of the provision of market research, market development and marketing management services. In addition, with regard to a transaction in respect of the sale, purchase or lease of intangible property, the term “intangible property” has been defined to include: marketing related intangible assets, such as trademarks, trade names, brand names and logos. The issue of marketing intangibles is not about incurring AMP expenses, it is about incurring non-routine or excessive AMP expenses by the taxpayer vis-à-vis the AMP expenses incurred by independent comparable companies. The tax authorities contended that the AMP expenses incurred by the taxpayer are in the nature of ‘provision of service’ since there is an arrangement, understanding or action in concert between the taxpayer and its AE for incurring such expenses which resulted into market development of AE. For AMP expenses to qualify as an international transaction, it would first need to be a “service” per se. This, as per OECD Transfer Pricing Guidelines (Para 7.6), can be determined by considering whether an independent enterprise under comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise. Here, it would also be important to see the key outcome of the SB ruling and the Delhi HC ruling on this issue. The details of the same are as under: Special Bench Ruling
HC Ruling
The SB held that an agreement between the AEs can be formal or in writing or informal or oral. The critical test would be the conduct of the parties to the transaction. If the taxpayer has advertised the brand of the AE, then it can be inferred that there is an understanding between the taxpayer and its AE to this effect. Further, the excessive AMP expenses incurred by the taxpayer visà-vis independent comparable companies, gives further weights to this inference.
The HC held that the taxpayers have asserted that the declared price of the international transaction involving the importation of goods from a foreign AE which included an element or function of AMP expense, for which they stand duly compensated in their margins or the arm’ s length price as computed. Accordingly, the argument that it is not international transaction is incorrect.
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______________________________________________________________________ Both the SB ruling and the HC ruling held that incurring AMP expense is an international transactions under the Indian transfer pricing regulations. For considering AMP as an international transaction, the fundamental question needs to be answered is: Whether in all the scenarios, the AMP expenses incurred by the AE (licensee) should be considered as international transactions in the nature of ‘provision of service’ between two AEs; and whether incurring of such expenses can be characterised as a transaction as a result of implied understanding or arrangement between the AEs. If the taxpayer believes that it has not incurred excess or non-routine AMP expenses for the benefit of its AE, e.g. The taxpayer operates as a licensed manufacturer(entrepreneur) and it has incurred excessive AMP expenses (vis-à-vis comparable companies) for its own business only. Further, the licensed manufacturer (entrepreneur) carries out the entire manufacturing of finished goods on its own account and risk, and consequently entitled to the residual or entrepreneurial profits, inter-alia relating to economic ownership / exploitation of the intangibles. In that scenario, the AMP expenses may not be considered as international transaction. However, in any scenario, the routine AMP expenses incurred by the taxpayer should not be considered as international transaction. If there is any provision of service, it can only through the non-routine or excessive part of the total AMP expenditure. The taxpayer is required to identify the international transaction at the time of annual transfer pricing compliance. In relation to the AMP expenses, it would not be very straightforward to analyse and conclude whether the AMP expense is resulted into any provision of service to its AE or not. The ideal course of action would have been to first judge whether a market or brand development service per se exists – this can be judged from the contractual relationship and the conduct of the parties, and more importantly the risk-reward aspect (i.e., whether the contractual relationship or the transfer pricing policy in place, adequately rewards the functions of the Indian entity). Further, if the taxpayer is characterised as an entrepreneur, an appropriate benchmarking methodology should be followed for supporting its entrepreneurial functions i.e. the AEs should be selected as tested parties to benchmark the routine transactions.
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Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ 4.2 Economic Ownership Ownership of intangibles is an important determinant while analysing the issue of marketing intangibles. In a scenario, where the Indian licensee characterised as an economic owner, (i.e. it performs functions, assumes risk and bears the cost related to development of intangibles and also entirely entitled to the residual profit/loss generated by exploitation of intangibles ), its marketing efforts may not result into ‘provision of any service’ to its foreign parent company.
Here, it is not denied that marketing efforts made by Indian licensee shall not benefit its foreign parent company. The foreign parent company may avail incident benefits from the marketing efforts of its licensee. However, since the licensee is the economic owner of the intangibles created in India i.e. assumes all the risks related to the development or creation of intangibles, the Indian entity may not to be separately remunerated for its marketing efforts. Para 6.76 to Para 6.78 of the OECD’s BEPS report implicitly discussed in relation to marketing activities performed by an enterprise that does not own the trademarks or trade names. The question is how the marketer should be compensated as a service provider or if in any case whether it should be entitled to an additional return based on economic ownership. To the extent the significant people functions with respect to framing strategies around AMP, are carried out by the taxpayer in the capacity of licensee of the brand, the entity becomes the economic owner of such marketing intangibles. If in the event of a transfer of the legal rights in the brand, the licensed exploited by a licensee is not terminated, then the licensee should not ideally be entitled to a compensation for such transfer. Also, in such circumstances, the price payable by the buyer of the brand to the seller might be on the lower side, in case a significant value stands associated with the economic ownership thereof in the hands of the licensee. On the other hand, if during the transfer of the legal rights in the brand, the license enjoyed by the distributor is terminated, then the licensee might seek compensation from the legal owner of the brand. This would depend on the terms of the contract, level of investment made by the distributor under the assumption of long-term rights in the license, practice/ custom followed in the relevant country, etc. Incidentally, this is the key aspect of ‘‘exit charge’’, which tax authorities across the world scrutinizing in the context of business restructuring transactions. This principle has also been upheld by the Authority for Advance Rulings of India while deciding on the taxability of income
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______________________________________________________________________ arising from the sale of brand, trademark and brewing intellectual property by Fosters Australia Limited to SAB Miller in India. The SB ruling and the Delhi HC ruling dealt with the concept of economic ownership and the outcome of the same is as follows:
Special Bench Ruling
HC Ruling
As per the SB ruling in case of LG Electronics, economic ownership of a brand exists only in a commercial sense, and in the context of the Indian Income-tax Act, 1961, it is only the legal ownership which is recognized.
The Delhi HC decision has given importance to the concept of economic ownership in case of distributors. The Delhi HC has upheld that the economic owner must be adequately compensated for its economic ownership in event of alienation of intangibles.
Ownership of intangibles and the returns attributable to the same, are the heart of the whole debate of marketing intangibles. The Delhi HC ruling as rejected the contention of the SB ruling and blessed the concept of economic ownership while analysing the issue of marketing intangibles. The Delhi HC has further given emphasis to the detailed FAR analysis while performing comparability analysis for the purpose of computing the ALP of AMP expenses. The concept of economic ownership was recognised by the Indian Government in its Administrative Circular No.6 of 2013 [Circular on conditions relevant to identify development centres engaged in contract R&D services with insignificant risk].The Circular refers to ‘economic ownership’ while laying down guidelines for identifying Contract R&D Centres. The Circular states: “Indian Development Centre has no ownership right (legal or economic) on the outcome of the research which vests with the foreign principal and that this is evident from the contract as well as from the conduct of the parties” The burden to prove the economic ownership lies with the taxpayer. It is utmost important that the taxpayer should perform a detailed analysis regarding its characterisation and document the same appropriately in the transfer pricing documentation and the inter-company agreements. The taxpayer should also maintain documents which evidence its roles and responsibilities as an economic owner.
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______________________________________________________________________ 4.3 Benchmarking of AMP Expenses From the above discussion, one of the outcomes is that one cannot completely disregard the issue of marketing intangibles. However, it is challenging for the taxpayer to justify that it has incurred only routine nature of AMP expenditure or it has not incurred any excessive or non-routine expenditure, since the whole exercise is very factual and quantification of the benefits is not very straightforward. Before the ruling of the Delhi HC, the tax authorities had considered the tool of BLT for benchmarking the alleged AMP expenses and the taxpayer have not been using the tool due to the prima facie contention that the AMP expenditure is not an international transaction hence the ALP principles do not apply to the same. The Delhi HC has disregarded the BLT concept and held that computation of the ALP for any excessive AMP shall be computed as per the methods prescribed under the Act. AMP expenses is a payment made by the taxpayer to third party media agencies and it is not in the nature of direct transaction with the AE. Non-routine or excess AMP expenses may be considered as a transaction in the nature of ‘provision of service’ and benchmarking of the same may be required to compute the ALP of non-routine AMP expenses. This section evaluates the guidance provided by the HC ruling for benchmarking the AMP expenses. The benchmarking of AMP expenses may pose challenge for the taxpayer since business realities of the each company is different. The product for AMP expenditure is incurred could have a different market, different customers, different life cycle and different strategies than the products of the third party comparable companies. There could differences between the products, markets and the AMP strategies followed by the taxpayer and the products, markets and AMP strategies followed by the independent third party companies, however, there is no such mechanism available to perform comparability adjustment in order to mitigate those differences for the purpose of arm’s length computation. The HC has provided a detailed guidance for benchmarking the AMP expenses. Key principles of the same are as follows: Aggregation of Transactions The Delhi HC has held that in a situation where multiple transactions are so interlinked that they cannot be evaluated on separate basis, aggregation of transaction is desirable.
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______________________________________________________________________ The HC has concluded that the compensation for AMP expenses may be subsumed in the purchase price of goods imported from AEs or a lower charge for royalty. The HC held that the arm’s length nature of the arrangement may be tested by way of an aggregate or bundled analysis with other transactions relating to the distribution activity. If the tax authority seeks to unbundle the transactions, the tax authority should clarify its reasons for doing so. This was the very important principle laid down by the Delhi HC whereby the doors were opened to benchmark the AMP expenses as per the methods prescribed under the Act. The HC held that the tax authorities should conduct a detailed FAR analysis to examine whether the AMP transaction are inter-related with the other routine transactions of the taxpayer. Method to compute ALP The Delhi HC held that there was nothing in the Income Tax Act, 1961 or the Income Tax Rules, 1962 to hold that it was obligatory for the AMP expenses to be subject to ‘Bright Line Test’ and the non-routine AMP expenses as a separate international transaction. Accordingly, the taxpayer is required to compute the ALP of the ruling as per the methods prescribed under the Indian Transfer Pricing regulations. The Delhi HC has granted relief to the taxpayers by holding that if aggregated transaction is concluded to be at ALP by applying TNMM or RPM, there is no need to bifurcate and treat AMP expense as a separate international transaction. If the margin of the taxpayer (for the aggregated transaction, including AMP expenses) is higher than the margins earned by comparable companies, the taxpayer is not required to receive any separate remuneration from its AE on account of AMP expenses. In a scenario, where the aggregation of transaction is not possible, e.g. where the taxpayer has considered Comparable Uncontrolled Price (‘CUP’) method for benchmarking its routine transactions other than AMP. The Delhi HC has not provided clear guidance to deal with this scenario. In such case, the taxpayer can perform a secondary benchmarking analysis by aggregating the routine transaction with AMP transaction and compute the net level profitability on an aggregated basis based on TNMM method. Comparability analysis The distributor’s contribution towards brand building should be assessed based on what an independent distributor would receive in comparable circumstances. The distributor’s efforts may be contributing the value of its own intangibles, as an economic owner. An independent distributor in such cases would not typically require additional remuneration from the owner of Page | 28
Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ the trademark or other intangibles. Even in situations where separate remuneration may be necessary, such remuneration may take the form of higher distribution profits or a reduction in royalty rate. A detailed comparability analysis should be required to find out appropriate comparables for benchmarking the AMP expenses. In case of aggregated approach, e.g. in case of distributor, the import transaction is aggregated with AMP functions, the taxpayer should performed detailed FAR analysis of independent companies for find out appropriate comparable distributors having FAR profile similar to the taxpayer. The Delhi HC ruling has given emphasis on the selection of the right comparables after completion of a detailed FAR analysis. The Delhi HC has given emphasis on the relevance of the intensity of the AMP function in the choice of potential comparables. However, the Delhi HC has not provided specific guidance to quantity the intensity of functions while selecting comparables. Benchmarking of AMP expenses is not straightforward since before the benchmarking the taxpayer needs to evaluate whether the AMP expenses is in the nature of service per se. In this regard one should keep in mind certain factors i.e., the level and composition of AMP would be a function of several factors such as lifecycle of the brand, product launch, useful life of the AMP, management intent and vision, industry specific nuances, etc. In case the AMP expenses is considered to be service rendered to the AE, the next challenge is to benchmark the transaction either with aggregation approach as upheld by the Delhi HC ruling or to benchmark separately. The whole analysis and exercise is very factual in nature. The taxpayer should perform a detailed FAR and assess its business realities vis-à-vis the independent companies before finalizing the approach. The approach should be aligned with the business and economic realities. 4.4 Application in case of Manufacturers The Delhi HC has commented on the economic ownership concept in case of distributors. The HC has not specifically mentioned whether the ratio of the ruling shall equally applicable in case of manufacturers also. The concept of economic ownership does not distinguish between manufacturer and distributor, since both have the capabilities to become the economic owners by alienation of intangibles. Further, in both the models, the respective entities are responsible for the development, Page | 29
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______________________________________________________________________ maintenance & enhancement of intangibles, though its efforts and accordingly responsible for the entire residual profit/losses after arm’s length payment to its AE towards finished goods, raw material, royalty etc. Accordingly, the key question is to be answered is whether the licensed manufactured incurring AMP expenses for its own business or for the benefit of the AE. In a normal business scenario, a licensed manufacturer operates as an entrepreneur since it undertakes heavy business investment and assumes related risks for manufacturing and selling goods based on the technology/trademark licensed received from its AE. For a licensed manufacturer (entrepreneur) the whole issue of marketing intangibles is misnomer since the AMP expenses shall not result into any services rendered to its AE. In a scenario where the tax authorities contend that the taxpayer (manufacturer) has benefited its foreign AE by incurring excessive AMP expenditure, the question arises whether the benchmarking ratio provided by the Delhi HC can be equally applied in case of manufacturer whose international transactions are raw material, payment of royalty etc. Delhi Tribunal ruling in case of Perfetti Van Melle India Private Limited has held that in case of a manufacturer, the international transactions concerned with the manufacturing activity cannot be aggregated with the AMP activities, as both are separate and distinct. Here, one need to further analyse, if the AMP expenses can be aggregated with the distribution functions (import and re-sale), what are the factors which are restricting the AMP expenses for aggregating it with manufacturing operations. One may take an argument that payment of trademark royalty is linked with the use of the brand and AMP expenses may also be connected with the brand of the product for which the expenses are incurred. Accordingly, the AMP expenses can be aggregated with the international transactions of a manufacturer and the ratio of the Delhi HC can also be applied in arriving at the ALP of excessive AMP transaction. In view of the above, a detailed FAR analysis of the manufacturing entity shall be required to: (i) Identify if the licensed manufacturer is the economic owner and accordingly issue of marketing intangibles is not relevant ; or (ii) Evaluate whether the AMP transaction can be aggregated with the international transaction pertaining to the manufacturing segment for the purpose of benchmarking.
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5. Case Studies 5.1 Normal Distributor
A Inc.
Outside India India
B Limited
-
A Inc. is the legal owner of the product/brand ‘X’. A Ltd. has licensed B Ltd. to distribute the product ‘X’ in India
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B Ltd. imports Products ‘X’ from A Inc. at mutually agreed price and sales to third party customers in India
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B Ltd. is characterized as a normal distributor and A Ltd. is a principal manufacturer. Any risk relating to marketing efforts borne by B Ltd.
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The AMP to sales ratio of B Ltd is 15%. The AMP to sales ratio of independent comparable companies is 5%
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B Ltd. has selected TNMM method for benchmarking its import transaction
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The operating margin of B Ltd. is 9%. The average operating margin of comparable companies is 4%.
Since B Ltd. has incurred excessive AMP expenditure as compared to the AMP expenses incurred by its comparable companies, the excessive AMP expenses may be considered as international transaction. However, the taxpayer may aggregate the AMP transaction with distribution operation by applying the principle of aggregation and perform benchmarking on an aggregated basis. Since, the aggregated operating margin of B Ltd. is at ALP, no separate remuneration warranted for the excessive AMP expenses. Page | 31
Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ In a scenario, where the B Ltd.’s operating margin is lower than the margins earned by comparable companies, the B Ltd. may be required to be compensated for the excessive AMP spend by a reduction in purchase price or direct compensation by A Inc. to B Ltd. Further, there could also be a scenario where B Ltd. operates as a full-fledged distributor and incurs AMP expenses as part of its own business functions. Any risk relating to marketing and advertising activity is directly borne by B Ltd and B Ltd. is directly benefiting from the marketing functions in the form of increased sales and market turnover. As per the OECD Transfer Pricing Guidelines10, the term of distribution arrangement is an important factor in determining whether the distributor is entitled to a return on AMP expenditure. As per the guidelines, if the distribution arrangement is long term and if the distributor, i.e. entity B Ltd, is the sole distributor of goods, then the distributor is the sole beneficiary of the marketing and promotion activity and there is, therefore, no need for additional remuneration to be paid by entity A Inc. 5.2 Limited Risk Distributor -
Referring the illustration of earlier case study, B Ltd. operates as a Limited Risk Distributor (‘LRD’)
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B’ Ltd. is entitled to a study returns for its distribution functions in India and undertakes limited functions and risk.
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The principal manufacturer (viz. A Inc.) would typically give a low, but steady remuneration in the form of a guaranteed return on sales (‘ROS’) to the distributor, which can be achieved either through adjustment of pricing of products or reimbursement of expenses.
-
Further, B Ltd. incurs AMP expenditure on the directions and control of A Inc. and is compensated for incurring such expenditure in the form of reimbursements.
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B Ltd. is not entitled to receive any additional compensation for the development of intangibles since B Ltd. only performs co-ordination functions related to marketing activities at the behest and based upon the strategies of behalf of A Inc.
-
B Ltd. does not control the functions and risks associated with the development of intangibles. The funding for the Indian market is provided and the key risks are borne by A Inc. only.
10
Para 6.75 of the Guidelines
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Marketing Intangibles- A Critical Analysis of the Transfer Pricing Debate | Ajit Kumar Jain
______________________________________________________________________ In case of an LRD, the issue of marketing intangibles may not be relevant since the LRD is remunerated with the steady margin after considering all sorts of direct and indirect expenses including the routine AMP expenses. In a scenario, where the LRD incurs non-routine AMP expenses in India on behalf of the foreign principle manufacturer, the LRD should be separately compensated for those expenses by way of higher return on sales or adjustment in the purchase price of goods.
5.3 Licensed Manufacturer -
Referring the illustration of case study as per Para 5.1, instead of normal distributor B Ltd. operates as an licensed entrepreneur
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Procure raw materials either locally and/or from the A Inc., manufacture final products using AE’s technology and selling under AE’s brand
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Bear all operational risks, viz., market risks, price risk, product liability risk, credit risk, foreign exchange risk, capacity utilization risk, inventory risk, manpower risk, etc.
-
B Ltd. pays royalty to A Inc. “use” of the technology and brand, and has nothing to do with creation or not of marketing intangible.
Since the B Ltd. is an entrepreneur, it cannot be benchmarked selecting B Ltd as the tested party, and thus the AMP spend cannot be challenged as being in “excess” – as there exists no comparable for an entrepreneur. Further, as discussed above, the benefit of AMP vests entirely with the B Ltd. For both these reasons, there may not be question of excess AMP being incurred for the benefit of the A Inc., and accordingly, the issue of marketing intangibles becomes irrelevant.
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______________________________________________________________________
6. Conclusion & Way Forward The tax authorities across the globe are very aggressive in scrutinizing the cross-border transaction involving development or enhancement of marketing intangibles. Such increased focus can be evident from the recent OECD’s final BEPS report on ‘aligning transfer pricing outcome with value creations’ wherein the definition of ‘marketing intangibles’ is widened vis-àvis the earlier definition as per the OECD transfer pricing guidelines. Further, the OECD has also provided a detailed guidance in relation to arm’s length treatment of AMP expenses in various scenarios. In India, the issue of marketing intangibles has evolved in the last couple of years. The HC ruling was landmark ruling which sets essential principles of law to be applied while dealing with this issue. The HC ruling brought in the fundamentals of transfer pricing while determining the ALP of AMP expenses. These fundamentals should be relied upon by the taxpayer while analyzing the arm’s length treatment of AMP expenses. Characterization of entity pays a vital role in determining whether a separate remuneration on account of AMP is required or not. It is utmost important for the taxpayer to document detailed FAR analysis and contractual obligations which support its actual characterization in line with the business and economic realities. Where the taxpayer operates as an entrepreneur and incurs AMP expenses as an economic owner, its marketing efforts may not be considered as a service rendered to its AE. Every taxpayer (licensee) should attempt to answer the fundamental questions viz. whether the taxpayer has performed any service to its AE (licensor) by incurring any AMP expenses. While application of BLT is rejected by the Delhi HC, the HC granted relief by holding that if bundled transactions are concluded to be at arm’ s length by applying the TNMM or RPM, then there is no need to bifurcate and treat AMP activities as a separate transaction. This is a great relief for the taxpayers those who have earned a good amount of margins and still faced significant transfer pricing adjustments on account of AMP expenses. The principle laid down by the HC ruling will go a long way in guiding both the taxpayer and tax authorities for dealing with this issue. The taxpayer should stick to the fundamental of the transfer pricing and consider the business and economic realities while applying the arm’s length principle to the AMP expenses.
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Bibliography 1. OECD (2010), Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, ISBN 978-92-64-09018-7
2. OECD/G20 Base Erosion and Profit Shifting Project- Aligning Transfer Pricing Outcome with Value Creation, Action 8-10 Final Report, ISBN 978-92-64-24123-7
3. ATO Guidelines on Marketing Intangibles www.transferpricing.com/pdf/Australia_marketing_intangibles.pdf
4. Income Tax Act, 1961 5. United Nations (2013), Practical Manual on Transfer Pricing for Developing Countries, United Nations Department of Economic & Social Affairs http://www.un.org/esa/ffd/documents/UN_Manual_TransferPricing.pdf
6. The HM Revenue and Customs, UK- Transfer Pricing Manual http://webarchive.nationalarchives.gov.uk/+/http://www.hmrc.gov.uk/manuals/intmanual/intm46 4070.htm
7. The definition, ownership and transfer issues around intangible property under the OECD Transfer Pricing guidelines, Marielle van Gorp Thesis supervisor: P.J.J.M. Peeters http://arno.uvt.nl/show.cgi?fid=122166
8. CBDT Circular 6, 2013 9. Foster's Australia Limited vs Commissioner A.A.R. No. 736 of 2006 10. DHL Corp. Et al v. Comm’r, T.C. Memo. 1998-461 11. Maruti Suzuki Vs CIT [Delhi High Court W.P.No. 6876/2008 dated 01.07.2010] 12. LG Electronics India Pvt Ltd v. ACIT [2013] 29 taxmann.com 300 (Delhi-Tribunal)(SB) 13. BMW India Private Limited v. ACIT [2014] 146 ITD 165 (DEL) 14. Sony Ericsson Mobile Communications India Pvt. Ltd.1 (Taxpayer) vs Commissioner of Incometax
15. Perfetti Van Melle India Private Limited v. ACIT ITA No. 407/Del/2015
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