marketing intangibles - current dynamics
TRANSCRIPT
MARKETING INTANGIBLES –CURRENT DYNAMICS
July, 2015
CONTENTS
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• INTRODUCTION TO TAX POLICY
• STORY SO FAR
• APPROACH(ES)
• DOCUMENTATION APPROACH
• APA STRATEGY
• QUESTION & ANSWERS
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INTRODUCTION TO TAX POLICY
Per Capita GDP, PPP (Current International $)
5
5,056.0
15,507.2 12,596.7
India Brazil South Africa
Tax-GDP Ratio: Corporate Income Tax to GDP
6
24.6
3.60 4.00 5.00
India Brazil South Africa
16.3
26.324.6
Non-Resident Withholding
7
Corporate tax collections
Non-residentwithholding component
9%
Transfer Pricing Adjustments
8
23,237
44,531
70,016
2010-11 2011-12 2012-13FY FY FY
Transfer Pricing Adjustments (Cont.)
9
2.983.23
3.56
0.08 0.15 0.23
2010-11 2011-12 2012-13
Total corporate tax revenue Potential tax effect of transfer pricing adjustments
Taxpayers Bearing the Brunt – in India
10
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STORY SO FAR
Story so Far
Penetration of the global brands in India, with liberalisation of the economy
Competitive Indian market – promotion of brands by publicity and advertisement
Advertisement, Marketing and Promotion (“AMP”) expenditure’ incurred for promotingIndian sales (by Indian entity)
The Revenue Authorities disallowed deduction of AMP expenditure since brandsowned by overseas Associated Enterprise (‘AE’) were promote
Courts / Tribunal allowed deduction as the expenditures were for “businesspurposes”
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The Revenue realigned their approach towards AMP expenditure
Issue entered the realm of Transfer Pricing controversy
It contended that AMP expenditure, incurred by Indian enterprise, benefits overseas AEby creation / development of their marketing intangible in India
The Revenue contended that Indian entity should be compensated for providing AMPservices by applying:
'Bright Line Test' as per decision of US Tax Court in DHL Inc.’s case
‘Mark up’ for the marketing / brand development services
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Story so Far
LG Electronics (ITAT - Special Bench) laid down:
Non-routine AMP expenditure for Brands owned by the overseas AE- ‘InternationalTransaction’
Use of Bright Line Test to determine value of transaction - upheld
The transaction, being in the nature of ‘provision of service’, requires mark-up
Sales expenses / cost not covered
14 parameters were laid down for determination of ALP
Special Bench order applied in other cases and further laid down:
Subsidy received by Indian entity – reduce while computing arm’s length price
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Aggrieved, taxpayers and Revenue filed appeals before the Delhi High Court (‘HC’)
Year 2013
Story so Far
Whether TPO has jurisdiction to benchmark AMP expenses
Whether AMP expense constitutes International Transaction
Whether adjustment can be made by TPO in respect of AMP expenses
Whether Cost Plus Method can be applied to compute adjustment
Whether fresh benchmarking should be undertaken by TPO
Whether selling expenses should be considered as part of AMP expenses
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Issues before the High Court
Story so Far
Decision of the Delhi High Court in Sony Ericsson: TPO entitled to suo-moto examination of such transaction
Upheld contention of ‘International Transaction’
Distribution and Marketing functions are inter-connected and inter-twined
Adjustment can be made in relation to ‘International Transaction’
‘Bright Line Test’ is not a method under the statute
Aggregation approach or Segregation approach can be adopted
Comparable should be functionally comparable and must not be Brand owner
Set-off is not barred / prohibited under the statute
Direct marketing and selling expenses not form part of the AMP expenses.
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Year 2015
Story so Far
Issue ITAT Special Bench HC of Delhi
AMP - International Transaction Yes Yes
Bright line test - to bifurcate routine
and non-routine expense Yes No
Whether AMP expense amounts to
brand building service
Yes
Non-routine AMP
expense constitutes
brand building service
Not Necessary
Brand building is not
equivalent or substantial
attribute of AMP
Aggregation of International
transactionsNot permissible Permissible
Set-off among various international
transactionsNot permissible Permissible
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Comparative Analysis – ITAT Special Bench vs HC of Delhi
Story so Far
Toshiba India, ITAT - Delhi :
AMP functions of the comparable should be similar to Indian entity while benchmarkingtransaction on aggregate basis
If suitable comparable not available – segregation approach followed
Matter remanded to the TPO for examination of AMP functions and determination of ALP
Ratio followed in: Zimmer
Casio
Perfetti Van Melle
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Year 2015
Story so Far
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APPROACH(ES)
AMBIGUITY IN HC’s ORDER:
AMP expenditure independent international transaction OR integrated functions of adistributor ie distribution and marketing
AMP function vs AMP expenditure
“An external comparable should perform similar AMP functions…In case acomparable does not perform AMP functions in the marketing operations, a functionwhich is performed by the tested party, the comparable may have to be discarded.…Comparable analysis of the tested party and the comparable would includereference to AMP expenses”
What are AMP functions and how to compare AMP functions - Magnitude or Nature
How can Assessee obtain information (relating to AMP functions), which is notreported
Treatment of subsidy received in relation to AMP expenditure
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APPROACH (ES)
Options
Seek directions from HC
SLP before the SC
Remand Proceeding before the AO / TPO
Formation of SB of
ITAT
APA
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APPROACH (ES)
DIRECTIONS FROM THE HC
Companies which were parties in appeal before the HC, can seek clarification /direction from the HC in relation to ambiguity arising from its order
SLP / APPEAL BEFORE THE SC
SLP / Appeal against the order of the HC can be filed before the Supreme Court(‘SC’)
Interested parties can join the proceedings before the SC
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APPROACH (ES)
APPEAL TO THE HC
Order of the ITAT is binding unless appealed
If not appealed, no further agitation in second round
Only non-compliance with earlier order can be challenged in second round
Recommendation : If order of the ITAT is contrary to the letter and spirit of its Order– Appeal to HC
FORMATION OF SB OF ITAT
Companies can approach the President of ITAT requesting him to constitute SpecialBench for adjudication on this issue which involving interest of multiple companies
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APPROACH (ES)
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DOCUMENTATION APPROACH
• SCOPE OF LAW
• BENCHMARKING APPROACHES POSTHIGH COURT ORDER
• PRACTICAL DIFFICULTIES
• COMPLIANCE DISCLOSURES
Scope of Law
Finance Act 2012 amended the definition of international transaction, by including an explanation, to include the marketing intangibles within the scope of the definition:
Intangible property transactions: Purchase, sale, transfer, lease or use of intangibleproperty, including …… copyrights, patents, trademarks, licenses, franchises, customer list,marketing channel, brand, ….
Provision of services: Provision of market research, market development, scientificresearch, legal or accounting service, etc.
Further, the Finance Act 2012 provided an explanation to define the term “intangibleproperty” for the purposes of an international transaction. It has defined the term toinclude:
“1.Marketing related intangible assets;……………..”
This amendment was effective retrospectively from the financial year 2001-02
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Post amendment, digressive views were adopted by Taxpayers
Benchmarking Approaches Post High Court Order
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Post Delhi High Court ruling, there are primarily 2 approaches under which international transaction of advertising, marketing and promotional (AMP) expenses can be benchmarked:
Aggregation approach – to be bundled with primary transaction• Resale Price Methodology (RPM)
• Transactional Net Margin Methodology (TNMM)
Segregation approach – to be benchmarked as a separate transaction• Cost plus
• Profit Split Methodology
• Any Other Method
Aggregation Approach
In case RPM is selected to benchmark the primary transaction along with AMP function:
Taxpayers to earn gross margin that commensurate’ s with the level of AMP functionsperformed
AMP expenses to be considered as a part of cost while computing profitability
Adjusted Gross Profit of Taxpayer to demonstrate the arm’s length nature of transaction
In case TNMM is selected to benchmark the primary transaction along with AMP function
A bundled approach would be adopted wherein AMP function would be aggregated andbenchmarked as one transaction
Accordingly, AMP expenses gets factored in the net profit while computing net margin
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Segregation Approach
Segregation approach in view of Delhi High Court ruling In case adjustment is not possible or comparables are not available, then, RPM or TNMM on
entity level would not be possible to benchmark AMP transaction
Accordingly, international transaction of AMP would be viewed in a de-bundled manner
In separately determining the arm’s length price of AMP expenses, the Tax authorities canchoose any other suitable method which may include cost plus method, PSM or Any othermethod
If segregation approach is adopted then a proper set off / purchase price adjustment shouldbe allowed
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Promotional expenses to be identified and reduced from advertising and marketing expenses
Practical Difficulties
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AGGREGATION APPROACH SEGREGATION APPROACH• Identification of appropriate
comparables?
• Difficulty in obtaining comparablesengaged in AMP functions similar toTaxpayer?
• Identifying brand owners?
• Difficulty in bifurcating brand buildingexpenses and sales relatedexpenses?
• Determining cost base?
• Difficulty in determining the purchaseprice adjustment?
• Basis of allocating return onintangibles under PSM?
Documentation Approach – Way Forward
Post Delhi High Court ruling, it is imperative for the Taxpayers to make appropriate disclosures of AMP expenses
To be disclosed as an international transaction
Disclosure in Form 3CEB• Disclose it as a separate transaction – Provision of brand building services?
• Aggregate it with primary transaction and disclosure by way of note or disclose it as any othertransaction in “clause 19”?
• Value of transaction to be disclosed excluding sales related expenses
Disclosure in Transfer Pricing report• Appropriate disclosure to be made in transfer pricing report – to avoid penalty exposure
• Choice of methodology?
• Stand on comparables?
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Potential penalty exposure for non-disclosures
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APA OPTION
APA – An OptionWorth Exploring?
Lack of clarity around the approach in remand proceedings
APA intended to arrive at negotiated, fact specific agreement
High Court Order stresses upon avoidance of double taxation – scope for bilateral APA
Characterization of the entity and the relevant business plans & strategy possible to be crystallized in an APA
Manufacturers and distributors to be dealt with differently: Questions for manufacturers arise around characterization and extent of international
transactions – functions (licensed manufacture or assembly), royalty/tech fee, managementfees extent of portable profits that are presently transferred
Questions for distributors are around the import pricing and if it already factors a return forthe marketing intangibles, characterization of distributor (for determination ofmethod), subsidy for AMP and treatment of promotion expenses
Persuasive value of international guidance from OECD and ATO
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Q & A