1. Introduction
Since its introduction in the Finance Bill 2001, transfer pricing provisions/regulations (TP regulations) have been a matter of huge debate & consequentially tremendous amount of litigations. Lack of conceptual clarity & high level of subjectivity in application of rules & various methods collated with strain of meeting higher revenue targets has added salt into the wounds of the assessee. Many large foreign MNCs have been facing high pitched assessments & have been asked to go through the rigors of the never ending judicial process to get justice. At a time when our economy is in need of foreign investments as emphasized by our Honorable Finance Minister during his budget speech 2013, there prevails a regime that is highly ambiguous & litigative rather than a clear & a simple regulatory regime that the foreign investors are looking for!!! There are N numbers of issues on which transfer pricing litigations have been going on, however some of the burning issues that are currently faced by various foreign MNCs could be summarized as following:
2. Issues
i) Marketing Intangible saga a dilemma for MNCs in India?[ LG Electronics India Pvt. Ltd (Delhi – SB) & Glaxo Smithkline Consumer Healthcare Ltd (Chandigarh ITAT relying on Delhi SB) ]
ii) Valuation of share transfer between two Associated Enterprises (AEs) [ Shell India, Vodafone, Nokia]
Let us try and analyse each of the issues separately:
i) Marketing Intangible saga- a dilemma for MNCs in India:
Facts in brief:
(a)The fact of the matter is that as part of the business arrangements usually foreign Associated Enterprise (AE) grant non-exclusive license to their Indian AE to use the brand name/ trade mark owned by them & in turn receives royalty payments as compensation.
(b)Pursuant to the license to use brand name, Indian AE incur advertisement, marketing and sales promotion expenses (AMP expenses) in India for marketing and promotion of the products manufactured or imported by them.
Issue:
(a)The revenue authorities are of the view that despite making payment of Royalty to foreign AE, Indian AE incurs disproportionately higher AMP expenses as compared to the peers in the similar industry, thereby developing / enhancing the foreign intangible / brand owned by the foreign AE & for which the foreign AE should compensate the Indian AE.
Tribunal Rulings:
LG Electronics India (Delhi Special Bench):
(a) According to the SB, what is relevant under Income Tax Law is legal ownership of intangibles & not an economic ownership. Economic ownership only prevails in commercial sense.
(b) It went on to consider the commercial rationality behind the incurring of such expenses by an independent enterprise & upheld the view that foreign intangibles are being developed / enhanced by the Indian AE by incurring disproportionately higher AMP which is considered to be a service rendered to the foreign AE & for which an adequate adjustment was warranted in the hands of the Indian AE in lieu of the compensation by the foreign AE.
(c) SB identified the following factors that should be considered while deciding on the adequacy of such adjustments:
¢ Whether the Indian AE is a distributor or manufacturer
¢ The extent of value addition made by the Indian AE
¢ Whether the goods sold by the Indian AE bear the same brand name as the foreign AE
¢ Whether the Indian AE is paying any royalty to the foreign AE
¢ Whether the royalty is comparable with what comparable uncontrolled enterprises would pay
¢ Whether the foreign AE is compensating the Indian AE for the promotion of the marketing intangibles
¢ Whether in the year under consideration the foreign AE is entering the India market or is an established brand in India
¢ Whether any new products are launched in India during the relevant period or the business is continuing with the existing range of products
¢ How the brand will be dealt with after termination of the agreement between AEs
Glaxo Smithkline Consumer Healthcare Ltd (Chandigarh ITAT):
(a) Relying on the Delhi SB ruling (supra), it upheld the adjustment for excessive AMP expenses in the hands of Indian AE.
(b) It further made some distinct observations that should be considered while deciding on the adequacy of such adjustments:
¢ 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 Indian AE.
ii) Valuation of share transfer between two AEs:
The fact of the matter is that as part of their commercial deliberation and as per the need of the hour transactions do take place between Indian AE & its foreign AE. One such transaction which is presently catching all the fame & limelight from the Taxmann is the transfer of shares by Indian AE to its foreign AE & notably the price at which such transaction takes place.
The revenue authorities are of the view that the shares are transferred at a lower price than its actual fair market value and such difference is chargeable to tax in the hands of Indian AE.
Prima facie it seems that the revenue authorities are actually focusing too much on the economics aspect of the transaction and forgetting the basics of Income Tax Act. Even though by virtue of Finance Act 2012 certain capital transactions have been clarified to always been covered within the purview of transfer pricing provisions application of the same to share transfers between two AEs would tantamount to violation of the basic provision of the Income Tax Act i.e. capital receipts are not chargeable to tax.
The issue is yet to be formally heard/ touched upon by any of the higher authorities/judiciaries. However, the spark that this has created amongst the business leaders as well the tax professionals over the globe, would definitely not fade away so soon and one has to wait for the views of the judicial authorities.
3. Comments
It is thus indeed worthwhile for the foreign MNCs to keep abreast themselves with the changes that are rapidly taking place within the Indian Income Tax environment & revisit their business strategies in line with the various judicial guidelines.
Tirthesh…Very nice article indeed.