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IP. Intangibles & Comparability

A Review of Marketing Intangibles in India

Posted by on 02 February 2016
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The issue of marketing intangibles in India has become very prominent, specifically with regards to the advertising, marketing and promotional (AMP) activities undertaken by the Indian taxpayer, where the brand owner is the foreign parent entity. In the recent transfer pricing audit cycles, Indian taxpayers incurring AMP expenses faced challenges, wherein the transfer pricing officers alleged that the activities giving rise to such expenses are identical to brand building and thus must be reimbursed by the brand owner, i.e. the foreign parent entity. In addition to such reimbursement, it is alleged that such AMP activities are in the nature of services being rendered to the parent for brand development, thereby warranting an additional service charge.

During March 2015, the Delhi High Court pronounced its much awaited ruling on marketing intangibles in the case of Sony Ericsson Mobile Communications India Pvt. Ltd. The ruling provides guidance on treatment of marketing intangibles where the taxpayer is characterised as a distributor.

The most significant takeaway from the High Court ruling is that it is not mandatory to subject AMP expenses to a bright-line test (1) and consider non-routine AMP activities as separate transactions. The High Court concluded that marketing and distribution functions are closely connected, and thus may be bundled for purposes of determining the arm’s length price.

The Indian Transfer Pricing Regulations were introduced in 2001 and are largely in line with the OECD Guidelines. The Finance Act 2012 has introduced additional provisions which enlarged the definition of “International Transaction” to include intangible properties including marketing intangibles, human assets, technology related intangibles, etc.

Paragraph 6.2 of Chapter VI of the 2010 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines)(2) defines the term “intangible property” as including “rights to use industrial assets such as patents, trademarks, trade names, designs or models”. It also includes literary and artistic property rights, and intellectual property such as know-how and trade secrets.

In the case of LG Electronics India Private Limited (LG Electronics), the Special Bench (3), based on the facts of the case, permitted the transfer pricing adjustment in relation to the AMP expenses incurred by the Indian taxpayer over and above the routine AMP expenditure, and accounted for the AMP activities as creating/improving the marketing intangible for and on behalf of the parent. Further, it held that it is permissible to earn a reasonable mark-up for rendering such services from the parent. Additionally it was held that economic ownership of a brand exists only in a commercial sense and, therefore, the AMP activities constitute international transactions that must be analysed separately.

Aggrieved by these adjustments, various affected taxpayers together filed appeals before the High Court, wherein essentially the rationale of the LG Electronics ruling was applied regardless of the individual fact pattern. The case involved a group of litigants, with the lead case being Sony Ericsson Mobile Communications India.(4)

The High Court concluded that the compensation for AMP expenses may be included in the purchase price of goods imported from associated enterprises or a lower charge for royalty. The Court 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. Hence, application of the bright-line test was also rejected.

Key take ways are as mentioned below:

• The contention that AMP activities were not an international transaction had to be rejected. The arm’s length determination pertains to the adequate compensation to the taxpayer for performing functions of marketing and incurring non-routine AMP expense in India.

• High Court provided substantial guidance on how to approach the issue of marketing intangibles, and highlighted that it is incorrect to state that AMP activities were directly attributable to brand building of the associated enterprise. Also, it held that benefit in the form of increase in sales could not be ignored.

• In the LG Electronics case, bright-line test was applied to determine the excessive AMP expenditure incurred for brand building. High Court held that it was unwanted, and hence rejected the application of bright-line test.

• High Court recognised the concept of economic ownership of intangible as the essential factor to arrive at an appropriate transfer price. “Economic” and “Legal” ownership may overlap at times basis the organisational structure/ factual arrangement within a corporate group.

BEPS Action plans have revised the OECD Chapter VI which provide guidance specially tailored to determine arm’s length conditions for transaction that involve the use or transfer of intangible. Summarised below are the key take away:

• “Legal ownership” of intangibles by an associated enterprise alone does not determine entitlement to returns from the exploitation of intangibles;

• Associated enterprises performing important value-creating functions related to the development, enhancement, maintenance, protection and exploitation of the intangibles can expect appropriate remuneration;

• An associated enterprise assuming risk in relation to the development, enhancement, maintenance, protection and exploitation of the intangibles must exercise control over the risks and have the financial capacity to assume the risks;

• An associated enterprise providing funding and assuming the related financials risks, but not performing any functions relating to the intangible, could generally only expect a risk-adjusted return on its funding.

Although Indian TP Regulations do not specifically provide guidelines on intangibles, other than defining them as part of “international transaction” under section 92B, however since the Indian courts follow OECD, the judicial pronouncements are in line with OECD Guidelines.

This article reflects the personal views of the author and does not reflect a formal position of Airtel India Limited on this subject.

    1. The bright-line test was espoused by the US Tax Court in DHL Inc. and Subsidiaries v. Commissioner. US: TC, 30 Dec. 1998, DHL Inc. and Subsidiaries v. Commissioner. The tax authorities typically applied the bright-line test to taxpayers by comparing the AMP expense as a percentage of sales of the taxpayer with that of comparable companies.
    2. OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD 2010)
    3. ITAT (Delhi)(SB), 17 May 2013, LG Electronics India Pvt. Ltd. v. ACIT, ITA 3823/Del/2009
    4. HC, 16 Mar. 2015, Sony Ericsson Mobile Communications India Pvt. Ltd. v. Commissioner, TS-96-High Court-2015(DEL)-TP


Vatika Bhatnagar

Vatika Bhatnagar, Transfer Pricing Manager at airtel Vatika Bhatnagar has extensive experience in transfer pricing, both in Consulting as well as Industry. She is presently working as a Transfer Pricing expert for Bharti Airtel’s foreign subsidiaries, which includes 17 subsidiaries in Africa and 10 in rest of the world. She is responsible for the Transfer Pricing policy and control of transfer pricing performance for all group companies. Apart from this, she is responsible for litigations in various countries involving transfer pricing matters. Prior to joining Airtel, she was part of PwC Transfer Pricing team, where her profile varied from transfer pricing litigation, advisory and compliance. Apart from this, she was responsible for evaluating and advising clients on intercompany transfers of tangible goods, intangible property, services and loans.
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