LG India is a subsidiary of LG, a Korean electrical products company. In a transfer pricing assessment, an Indian transfer pricing officer (TPO) deemed the AMP expenses of LG India to be excessive in relation to comparable companies.
The AMP was considered by the TPO to be connected to brand promotion for the Korean parent. The TPO said the promotion should have been compensated by the parent and not be recorded as an expense for tax deduction.
The TPO applied an adjustment to compensate for the difference. The taxpayer referred the case to the dispute resolution panel (DRP) but the DRP upheld the adjustment. The DRP also recommended a mark-up of the AMP. LG India then filed an appeal with the Delhi ITAT, which upheld the decisions of the TPO and DRP.
“The decision seems reasonable and fair on the taxpayers if, as a factual matter, it is indeed true that the level of advertising and marketing expenditure is abnormal and, in part, not for the benefit of the local company concerned,” said Colin Garwood, head of group tax for Intercontinental Hotels.
This is, said Garwood , consistent with the principles the OECD has started developing as part of its review of its transfer pricing guidance relating to intangibles.
“Indeed what is perhaps positive is that it sounds as though the matter was dealt with as a pricing issue affecting what charges should be made by the local company to the brand owner, rather than as a matter which dislodges the legal realities and gives the local company some deemed ownership interest in the underlying intangibles -that had been a concern with the draft update of the OECD guidelines,” Garwood added.
There are some controversial aspects to the ruling including:
· A wide interpretation of the term “transaction” to include implied arrangements between parties on account of control being exercise by parent;
· The acceptance of the bright-line test (clearly defined rules) imported from US regulations though not mentioned any where under Indian regulations;
· The requirement of the taxpayer to demonstrate specific benefits / subsidy received from the parent and not consider the higher gross / net margin as an implied benefit to offset the AMP spent.
“On legal principles, the special branch [of the ITAT] has left hardly any further line of defence,” said Ameet Patel of SKP Group, a member firm of Nexia International. “The taxpayers thus should be advised now to create their defences on the factual matrix of the case. Selection of the comparable cases for [Bright Line test] is of prime importance now. The taxpayers are also advised to [look again] at the classification of their AMP expenses into proper [categories] because expenses which are in nature of sales promotion need not be covered within the ambit of AMP expenses.”
If the ruling encourages recurrent factual challenges as to whether local advertising and marketing spend is excessive, it could be bad for taxpayers.
“It is important that a heavy burden of proof rests with the tax authorities in that respect and that this principle is only applied to related party circumstances which are clearly abnormal,” said Garwood.
Sanjiv Malhotra, of BMR Advisors was involved in the court proceedings and has written an in-depth analysis of the judgement.
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