Brand Equity Vs. Tax Equity - The AMP Controversy And The Taxman’s Dilemma
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Category: Taxation
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BRAND EQUITY VS. TAX EQUITY: THE AMP
CONTROVERSY AND THE TAXMAN’S DILEMMA Tanmay V. Dhakras, LLM (Taxation Law), Jindal Global Law School, Sonipat
ABSTRACT
Transfer pricing law has evolved in India with astonishing speed. India’s jurisprudence regarding transfer pricing cases has skyrocketed and the world acknowledges it. A key component of international tax, transfer pricing controls how multinationals deal with their Associated Enterprises (AEs). Since years now, the advertising, marketing and promotion (AMP) expenditures which are based upon market intangible assets is a major source of contention when they add to brand equity. The tax authorities of many jurisdictions have been contending that the issues related to these expenses which significantly contribute in the brand’s growth are not adequately termed as international transactions and hence, forego scrutiny.
This paper, examines the issues relating to marketing intangibles, the jurisprudence around it and also discusses the recent trends and existing positions of the Indian judiciary and that of the revenue regarding these market intangibles.
INTRODUCTION
Intangible Properties in general have been an issue of huge controversy around the Transfer pricing saga. Intangible Properties have been defined by the Transfer Pricing Guidelines of the OECD as, ‘The word “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’1. The encompassing term ‘intangible assets’ are synonymous to intellectual property, which something born from intellect and for its exploitation and use, the owner must sanction. It provides the owner with a string of rights to exploit and enjoy exclusive ownership of the property he/she deemed to have created.
Looking through the prism of taxation and accountancy, these intangibles are assets of the owner and hold considerable value in the books of accounts of the company. Therefore, a tax incidence occurs on this commercial activity of selling or acquiring of intellectual property i. e. intangibles. The explanation II in Section 92B of the Income Tax Act also defines intangibles in a very exhaustive definition ranging from Marketing to technology, engineering and data processing among others. However, even while examining definition, it will be an understatement to say that intellectual property presents itself as a unique challenge as it is devised by the individual out of his ingenuity but when applicable in a commercial stance, changes the entire nature of transactions as commercial value cannot be easily evaluated.
Therefore, establishing transfer pricing for transactions with intangible property used in market activities poses as a challenge. Before we move on to market intangibles and AMP (Advertising, Marketing and Promotional) expenses, I feel obligated to define transfer pricing in a simple format.
Transfer pricing law, in the most general sense, is establishing conditions on transactions
1 Pg. 28-29, Guidance on Transfer Pricing aspects of Intangibles, OECD 2014
between MNEs (Multinational Enterprises) and their controlled enterprises (or associated enterprises) located in different jurisdictions and the law says that such transactions are to be dealt with as if between the unrelated parties, accounts rewritten if required and real profits are to be taxed without manipulation. The transaction in short, must be arm’s length. Where the transfer price is different from the price which would have been charged if the enterprises were not associate and the difference gives rise the tax advantage, the tax is calculated on the basis of arm’s length price2. In transfer pricing; to put forth very simply, comparables are found to determine the Arm’s Length Price. After selecting the comparables, benchmark analysis is done to determine whether or not these enterprises are comparable or not.
Benchmarking in short is a process that compares a company’s transactions with similar transactions between independent companies. Intellectual property in brief, can be associated with broadly commercial activities which can be classified into two categories,
1. Trade intangibles such as patents, designs and models,
2. Market intangibles such as trademarks and trade names
We shall be dealing with market intangibles in this article as AMP expenses are specific to market intangibles. A trademark, performs three functions; a. it gives the product an identity of its own. b. it provides a guarantee to the consumers as well as the owner of its permanent status. c. it aids in promoting the product or the service brand name. Primarily the value of trademarks and marketing intangibles is closely related to marketing, promotion, and advertising. This value is influenced by a number of elements, such as the trade name or trademark's reliability and reputation, and formidably affected by factors such as marketability and promotion which in turn contributes to advertising. The distribution and accessibility of goods and services, research and development, and continuous quality control are also very important.
Additionally, investments in networks that support connections with distributors, agents, or other intermediaries, as well as the efficiency of promotional
2 Canada v. Glaxo Smith Kline Inc. 2012 SCC 52.
expenditures in raising client awareness, play a vital role. Their total value is also determined by the legal rights attached to them and the potential value of the market to which these intangibles grant access. In short, trademarks lose substantial value without adequate investment such as marketing, promotions, advertising etc3.
INTERNATIONAL
BACKGROUND
The OECD Transfer Pricing Guidelines (2017) highlight that transactions between related businesses should adhere to the arm's length principle, which states that prices should be comparable to those of transactions between independent businesses under similar circumstances. Numerous court rulings have cited the rules, especially those pertaining to AMP (Advertisement, Marketing, and Promotion) costs paid by domestic organizations on behalf of foreign affiliated businesses (AEs). The guidelines emphasize that a distributor's or marketer's excessive AMP spending may enhance the trademark and demand remuneration as payment for these services.
To determine if an adjustment is necessary, four key factors must be analyzed: (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 account of the assets used and risks assumed)4 According to the criteria, a domestic distributor may get compensation in the form of increased distribution margins, lower royalties, profit-sharing, or direct reimbursement if their AMP spending above industry standards. One of the examples given the guidelines is the following, Primair, a Country X-based watch manufacturer, owns the R trademark and decides to enter
3 Nestle Holdings, Inc. v. Commissioner T.C. Memo 1995-441
4 Chapter VI, pg.271-272, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations, 2022.
Country Y’s market, where R watches were previously unknown. To facilitate this, Primair establishes Company S, a wholly owned subsidiary in Country Y, to act as its exclusive distributor and marketing agent. Under a long-term, royalty-free agreement, Company S is granted the rights to market and distribute R watches in Country Y for five years, with an option to extend. However, Company S cannot re-export the watches and does not acquire ownership of the trademark beyond distribution rights. It imports, sells, and markets the watches but does not engage in manufacturing or secondary processing. Company S purchases watches from Primair, assumes inventory and credit risks, and executes marketing efforts in consultation with Primair.
While Primair designs the overall marketing strategy, approves budgets, and makes final advertising decisions, Company S provides local insights and implements the plan. In return, Company S receives a service fee from Primair, covering marketing expenses plus a profit mark-up. By Year 2, the R brand gains recognition in Country Y, and the compensation paid to Company S is confirmed to be at arm’s length, based on a comparability analysis with independent marketing agencies. Since Company S is adequately compensated, any additional profits derived from the R trademark in Country Y rightly belong to Primair, and no transfer pricing adjustments are required. According to the UN Practical Manual on Transfer Pricing (2017), a domestic distributor may create a marketing intangible that helps the foreign AE if its AMP costs are higher than those of similar independent distributors.
According to the handbook, two crucial elements need to be looked at:
1. Whether the distributor should earn more than similar independent distributors,
2. Whether the distributor's marketing efforts produce a unique intangible asset apart from the
foreign-owned brand. Regardless of the creation of a unique marketing intangible, a distributor should obtain higher returns if it is not reimbursed for its excess AMP spend. Using these justifications, Indian tax authorities have argued that excessive AMP expenditures ought to be subject to transfer price adjustments because they create legally owned intangible assets5. BEGINNING OF DISPUTES The issue of AMP Expenses has suffered a lot of back and forth. The very genesis of this issue stems from a US Tax Court case of DHL Corporation v. Commissioner of Internal Revenue6 and the ‘Bright Line Test’ was introduced to distinguish two components which were identified for the AMP expenditure. Routine expenses were included in the first component. These were calculated by multiplying the Assessee's sales amount by the average mean of the required ratio.
The second component consists of non-routine expenses that, when multiplied by the sales amount, exceeded the typical mean of the ratio. After applying a 15% markup for adjustment reasons to these non-routine AMP charges, the Arm's Length Price (ALP) was adjusted appropriately. The bright line test, can be simply explained that while every license or distributor is expected to spend certain amount of cost to exploit the items of intangible property top which it is provided, it is when investment crosses the ‘bright line’ of routine expenses into the realm of non-routine that, economic ownership likely in form of a market intangible is created7. The DHL case (supra) also referenced to the ‘Developer Assister Rules’.
These rules state that a company begin the developer is the person incurring the AMP expenses will be treated as the economic owner of the brand and the legal owner who is the assister in this case would not be required to be compensated for use or enjoyment of the label by the developer. 89 The bright line test was hence developed to distinguish as to at what point of time, does the legal consideration take a back seat and economic consideration becomes the title for enjoyment. N brief, it is the determinative of economic ownership and the consideration used for that is nonroutine expenses i. e. brand building rather than routine expenses such as casual expenses incurred.
5 UN Practical Manual on TP for Developing Countries (2017), Pg. 277
6 T.C. Memo 1998-461
7 Kriti Chawla, Transfer Pricing of Intangibles
An Evaluative Study under the OECD and the Indian Environment sept.2015
8 International Transfer Pricing 2013/14 P.W.C page 822-823
9 F.2d 855 (7th cir.)
The case of Eli Lilly and Co. v. CIR/Commissioner9 and Safety Boss Limited v. The Queen 10 are particularly peculiar as they observed important views. The first case saw that the assessee’s trademark and goodwill and held that the manufacturing know how was more important rather than trademarks. While in the latter case, the Canadian company, Safety Boss, provided remuneration to Mr. Miller, for his services. What was peculiar is that Mr. Miller was 99% shareholder. The revenue disallowed a portion in excess. It was held that it was the personal goodwill of Mr. Miller and that of his skills that the company benefitted. As the company had no goodwill other than that of Mr. Miller, the withholding of portion by revenue was unnecessary11. EXPERIENCE IN INDIA Now when it comes to Indian experience with AMP Expenses, it has been grudgingly difficult to come to a suitable conclusion.
The department continues to function with the Bright Line Test as a fundamental, while various Courts of the country have made it a point to not continue with the BLT in Indian context. The questions, as to whether such transaction is an international transaction and whether such resulting expense qualify as gains or loss are left now for the Hon’ble Supreme Court to clarify. However, the following table shall be a helpful tool to dissect the judgements;
10 (2000) DTC 1767
11 Taxmann’s Law of Transfer Pricing in India D.P. Mittal page 447 4th edition.
Court Party Name and Ratio and judgement Citation Delhi High Ma Maruti Suzuki Using a foreign trademark or logo voluntarily. Court and India Ltd. v. Addl. CIT/TPO12 Hon’ble A domestic company is exempt from paying a Supreme foreign company if it chooses to use that company's Court of trademark or logo on its goods, packaging, or containers. Required Use of International India Trademarks and Logos. The foreign entity must reimburse the domestic business for the marketing intangibles benefit if the domestic entity is compelled to utilize a foreign trademark or logo. Marketing, Promotion, and Advertising (AMP) Costs. If the domestic corporation's AMP expenses are comparable to what an independent domestic company in a comparable circumstance would normally incur, the foreign entity is not obligated to pay anything. i. e. arm’s length price.
The Supreme Court however, was not inclined by looking at the merits of the case and held that the TPO must not follow directions/comments made by the Delhi HC on merits.
ITAT Delhi L. G. Electronics India AMP expenses were held to be international (P. ) Ltd. v. transactions by the ITAT within the meaning of nonroutine AMP expenses by using the BLT as a Assistant test. It held that the BLT is a bifurcating tool. AMP Commissioner of Expenses cannot be treated at par with transaction of Income-tax, Circle - 3, purchase of goods. Noida13 AMP Expenses must be separately compensated irrespective of the further function yields more/profitable result. The ITAT also held that expenses in connection with sales which do not lead to brand promotion cannot be brought within ambit of AMP expenses for determining cost/value of international transaction. Correct approach under TNMM is to consider operating profit from each international transaction in relation to total cost or sales or capital employed, etc.
, of such international transaction and not net profit, total costs, sales, capital employed of assessee as a whole on entity level.
Delhi High Sony Ericsson Mobile This is in regards to the distributors group. The Communications question was that whether the AMP expenses Court India (P. ) Ltd. V. exceeding the threshold of Bright line are a separate Commissioner of international transaction. In the TP Study, the Income-tax -III14 assessee agreed that the group and it’s AEs owned a lot of intellectual properties, but the assessee does not. The assessee is just an importer engaged in distribution and marketing through the resale of imported handsets. The TPO Computed the liability by ratio of AMP Expenditure to sales and compared it with average mean of the same ratio to other comparable uncontrolled transactions of other companies.
The Hon'ble High Court decided in the Sony Ericsson case that the taxpayer distributors could not simultaneously argue that AMP expenses did not qualify as "international transactions" because they claimed that the benefits of their exorbitant AMP expenses were reflected in their distribution profit margins. After reaching this conclusion, the Court highlighted that a taxpayer distributor would normally need additional compensation for any additional functions they do as a result of AMP operations in comparison to similar companies. Such extra pay can be included in the margins for distribution or product pricing. The revenue authorities cannot impose a separate reimbursement for extra AMP expenses with a markup if the taxpayer has previously received such compensation. This is because doing so would result in double taxation, which is prohibited by law.
This led to proving that the BLT should not be operative in India. Delhi High Maruti Suzuki India AMP Expenses when assessed for a licensed Court ltd. v Commissioner of manufacturer on a stand-alone basis does not qualify as an international transaction. Only methodologies Income Tax15 under Rule 10B are prescribed for transfer pricing and not BLT. If the net profit margin of the taxpayer (Second Maruti Case) exceeds that of comparable independent companies, then no separate AMP adjustment is necessary. Emphasis on the overall profit based analysis rather than the BLT. The Court however, also emphasised the concept of economic ownership in brand building activities. A licensed manufacturer who incurs AMP Expenses contributes o the economic value of the brand in the domestic market, which benefits both the manufacturer and the brand owner.
However, that does not mean that such becomes obligatory for a foreign group to compensate domestic entity.
Commissioner of Income-tax v. Casio India Company (P. ) Ltd17 he assessee, a subsidiary of ‘C’ ltd. Japan, acted as a distribution channel in India and u=incurred AMP expenses during the relevant financial year. The TPO proposed an adjustment using the BLT, arguing that the assessee’s AMP spending exceeded the industrial benchmark and should have been compensated by the group. However, the Tribunal deleted this adjustment relying on prior rulings. This shows that the Department is unwilling to let these expenses go out of the preconditions of an international transaction. RECENT VIEW Recently, the Hon’ble Supreme Court dismissed the Revenue’s Special Leave Petition against the judgement of the Delhi High Court in CIT vs. Whirlpool of India18. Whirlpool of India Ltd. (WOIL), a subsidiary of Whirlpool Corporation, USA, operates in India’s home appliance industry.
The company manufactures and distributes products under a Trademark and License Agreement (TLA) with its Associated Enterprise (AE), Whirlpool USA, which involves royalty payments for the use of the trademark. During the financial year under review, WOIL incurred advertising, marketing, and promotion (AMP) expenses amounting to Rs. 180. 73 crore. This expenditure resulted in a high AMP-to-sales ratio of 11. 12%, significantly exceeding the industry benchmark of 3. 78%. The Revenue authorities contended that these AMP expenses conferred benefits upon the foreign AE by enhancing its brand value. Applying the Bright Line Test (BLT), they categorized the excess AMP spend—calculated as the difference between 11. 12% and 3. 78%—as an international transaction, leading to an adjustment of Rs. 129. 44 crore.
The Delhi High Court held that the Bright Line Test lacks all statutory basis and results into an arbitrary segregation of expenses. While it seemed that the debate over AMP settled by this judgement as the Hon’ble Supreme Court has refused to entertain revenue appeal, however, the reasoning behind nonentertainment of the appeal has not been described and the other important principle appeal of Canon India Pvt. Ltd. v. DCIT has not yet been decided and since it stands as a Civil Appeal, the Supreme Court shall record the reasons of dismissal or allowance and that will be done through a judgement.
17 [2025] 170 taxmann.com 374 (Delhi)[11-12-2024]
18 ITA Nos. 610/2014 and 228/2015
Also, the Hon’ble Supreme Court in Principal Commissioner of Income-tax v. Yakult Danone India (P.) Ltd19 granted the SLP against the High Court which had upheld the Tribunal’s order which was that the TPO’s construction of AMP expenses and holding that there was an international transaction was wrong and is liable to be deleted. So, we have to await the Supreme Court’s decisions regarding all these related cases.
CONCLUSION
AND FURTHER INSIGHTS Amongst various issues, two issues stand out the most. 1. AMP Expenses Are Classified as "International Transactions" under TNMM: The main point of contention is whether or whether AMP costs, particularly when using the Transactional Net Margin Method (TNMM), need to be handled as separate foreign transactions. TNMM does not break down individual transactions in order to assess net profit margins. 2. Benchmarking AMP Expenses: Selecting the best benchmarking technique becomes essential if AMP expenses are considered international transactions. Some courts have used the 'Bright Line Test' (BLT) to distinguish between ordinary and non-routine AMP expenses. There are uncertainties because Indian transfer pricing regulations do not specifically call for this approach.
Furthermore, different market situations and competitive environments that affect businesses' AMP spending make benchmarking difficult. The International Experience also does not clear the air on the subject. The Coca-Cola Company (TCCC) case dealt with similar AMP expenses issue. The TCCC sought that marketing intangibles were wasting assets and needed constant advertisement to retain value. The US tax Court, however disagreed and stated that the primary factor in determining intangibles was legal ownership and that TCCC’s advertising expense consistently improved the brand and IP20. The Court further went on to rule “even if advertising could be capitalized as intangible assets, TCCC failed to show how this would comport with economic substance, when advertising by the supply points supported “somebody else’s products” (being TCCC’s products). ”
19 299 Taxman 452 (SC)[05-04-2024]
20 Kluwer International Tax Blog, The Coca-Cola Company Ruling – Analysing the US Tax Court’s observations by Mukesh Butani (Managing Partner at BMR Legal) and Seema Kejriwal (BMR Legal)/December 18, 2020 The Indian question still remains to be seen as matters are lined up in front of the Supreme Court since 2016 now. While the judiciary shall take its own sweet times, taxpayers should be vigilant about supply chains, transfer pricing studies and operational costs/revenue generation regarding exploitation, operation, enjoyment of trademarks and brand value along with maintenance substance and other expenses.