The Supreme Court is set to decide whether the government can demand taxes on Indian arms of MNCs which report advertising and brand promotion expenses above the industry average.
The apex court is likely to take up the matter for hearing some time in November. The development is significant considering that more than a third of the R47,000 crore of income suppression that the income tax department alleged by MNCs in the 2014-15 audit stemmed from the advertising, marketing and promotional (AMP) expenses of their local arms.
Companies like Canon India, Daikin India and Sony Ericsson have already moved the apex court challenging a Delhi High Court order in March, which recognised the tax authority’s jurisdiction in the matter, but said the way it made income adjustments was arbitrary.
While companies have challenged the taxman’s right to subject promotional expenses to tax audits and make income adjustments, the income tax department, on the other hand, is set to file a cross appeal challenging the high court ruling that the approach followed in making income adjustments had no statutory backing. The court also had issued a set of principles for the tax man to follow.
The department’s tax notices pertain to transfer pricing adjustments from 2007-08 onwards. The High Court had referred the matter to the Income Tax Appellate Tribunal (ITAT), which only endorsed the former’s decision.
“As of now, there are no tax demands. It is for the Supreme Court to decide whether AMP expenses constitute an international transaction subject to transfer pricing. If that turns out to be the case, there would be a recomputation of the taxable income of the assessees. Otherwise, the matter ends there,” said a person advising one of the companies.
BMR Legal is representing Canon India while EY is advising Daikin India. Haier Appliances, Reebok India, Casio India and Discovery Communications are also facing tax notices on the issue.
The department claims that any AMP spending above industry average by the Indian user of a foreign brand name — say, a consumer goods seller spending 7% of its turnover for promotions when in the industry average is 3% —needs the excess spending to be reimbursed by the foreign owner of the brand, on which tax is applicable. The rationale is that promotional expense here leads to the creation of a part of the intangible (brand value) in India, which helps in enhancing the worldwide demand for the parents’ products, which gives the Indian associate a right over the proceeds of the brand.
The high court had ruled that the ‘bright line test’ followed by the department in making income adjustments has no statutory backing. The court also said that to assert that brand building is equivalent or substantial attribute of advertisement and sale promotion would be largely incorrect. It also held that selling expenses in the nature of trade and volume discounts, rebates and commission paid to retailers, cannot be included in AMP expenses.