The tax department has been zealously taking up the aspect of marketing intangibles. As a result, many taxpayers have witnessed large adjustments over the years on the basis that advertisement, marketing and promotion (AMP) expenditure was outside permissible arm’s length. The common questions raised include: Whether the promotional efforts of an Indian entity (licensee of trademark) enhance the value of the trademark legally owned by an associated enterprise? Whether the associated enterprise should compensate the Indian entity for the excessive AMP expenditure?

Given the importance of this issue, and the possibility of conflicting views from different benches, the questions were referred to a Special Bench of the Income Tax Appellate Tribunal, which recently gave its verdict.

LG Electronics India Pvt Ltd is a wholly-owned subsidiary of LG Electronics Inc. The latter allowed LGI to use its brand name and trademark on products manufactured in India. The tax authority alleged that LGI incurred excessive AMP expenses relative to comparable companies (referred to as the ‘bright line’ generally), and that the excess amount should be treated as brand promotion on behalf of LGK, entitling LGI to be compensated for these expenses with a mark-up. The majority Bench endorsed this approach, but referred the matter back for redetermination of the mark-up based on the factors outlined.

The Bench stated that the advertisement by LGI carrying the brand of its associated enterprise, coupled with the fact that it spent disproportionately higher amount on AMP expenses, gives clear inference of a brand promotion ‘transaction’ between the taxpayer and its associated enterprise .

The majority Bench also held that legal ownership — and not economic ownership — is what the law recognises. In transfer pricing, where there is a huge impetus on the functions, assets and risk analysis, attributing no weightage to economic ownership (which is established when an entity performs the relevant functions and incurs the related expenses) is against the basic principles of economics. If the Indian entity has borne the economic burden of promoting the brand here, the corresponding returns through brand exploitation should also reside with the Indian entity, more so when it functions as a manufacturer rather than a routine distributor.

Also, one cannot overlook that LGK is a global brand and that LGI leverages on this positioning in India. LGK does not charge royalty to LGI, and this fact should be given due weightage.

Further, though the Special Bench upheld the use of the ‘bright line’ method, it would be inappropriate to apply a mathematical concept squarely, as what is appropriate AMP for the business would depend on several commercial factors such as strategy, years in business, size, and market share. Selection of right comparables is, therefore, crucial.

It cannot be denied that LGI would not have benefitted, and it also cannot be argued that due to the strengthened brand the associated enterprise would not receive any future benefit, though incidental. It is therefore questionable whether the judgment has completely overlooked the benefit derived/ to be derived by LGI, or if the adjustment of AMP expenses is good enough.

These questions cannot be answered in absolute terms and would depend on the facts of each case. It would be irrational to search for a common thread for all taxpayers who incur higher AMP expenses.

Though the majority view is against the taxpayer, there is also a dissenting member view in favour. Considering the conflicting views, the issue of marketing intangible is here to stay and, therefore, one must critically analyse the implications of carrying out brand promotion in India.

Karishma R. Phatarphekar is Partner and Practice leader, Transfer Pricing Services, Grant Thornton India LLP

Vaishali Mane, DirectorTransfer Pricing Services, contributed to the article.

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