Given the number of cases involving the taxman questioning the advertisement and marketing promotion (AMP) expenses of MNC brands and settling these by adding these expenses back to their taxable profits—a third of transfer-pricing adjustments in FY15 related to such expenses—the Delhi High Court’s judgment on this comes as a breath of fresh air. More so since, earlier, the Bombay High Court had given substantial relief to firms like Vodafone and Shell who were also caught in the transfer-pricing net, though of a different kind. So, in the case of Sony Ericsson, the Indian entity had shown AMP-to-sales of 7.06%—the taxman, however, rejected the comparators given by Sony Ericsson and, instead, used a 3.35% number; the ‘additional’ spend was added back to that year’s taxable income. In the case of Reebok India, similarly, the AMP-sales of 12.33% was rejected in favour of a 2.51% number. In all such cases, the taxman argued the higher AMP was, in fact, expenditure being made to promote the foreign brand, and not to increase local sales.
The Delhi High Court has done well to come down on this while explaining that brand-building is a long-term and complicated exercise and depends upon a product’s quality and reputation—so linking it with AMP is not recommended. In a telling statement, the court says if the same parameters were ‘applied to Indian companies with reputed brands and substantial AMP expenses, (it) would lead to difficulty and unforeseen tax implications and complications’. The court also ruled that discounts and commissions had to be included as AMP expenses—this is another big area of tax dispute. Indeed, while outlining various criteria for how to use different transfer-pricing methods, the court has said ‘the endeavour should be to ascertain and satisfy whether the gross/net profit margin would duly account for AMP expenses’—in other words, if the profit margins are all right, the AMP must also be fine.
Which is why, while remanding the cases to the tax tribunal for another look, the court states its preference for ‘safe harbour rules’ since they ‘instil certainty and curtail litigation’. While that may be practical advice, the problem is the taxman’s ‘safe harbour’ norms—profit margins, essentially—are much higher than what industry finds acceptable; progress on signing Advance Pricing Agreements (APAs are elaborate agreements on how to treat various items of expenditure) has been equally slow. In which case, MNCs may still find themselves subject to the vagaries of the tax process, though there will be more of a check now. The court ruling that AMP spends of Indian subsidiaries of MNCs constitute an international transaction—and therefore fall under the ambit of transfer-pricing adjustments—is a blow for those in appeal against the taxman, and suggests the last may not have been heard on the issue of AMPs and royalty payments.