MNC arms await Supreme Court verdict on tax demand for Ads, promotion

As many 19 Indian arms of multinational companies are before the Supreme Court for a final answer on whether they have to pay tax on sizeable parts of 'advertising, marketing and sales promotion' (AMP) spent, which the Indian tax authorities believe is a brand-building exercise on behalf of the foreign parents of these companies.

According to the Income Tax (I-T) department, the AMP is a service rendered by the Indian companies to foreign parents. If the apex court rules in favour of the tax office, it could raise taxable income of many such companies as the tax department would disallow large portions of their AMP spent as expenditure in the profit and loss accounts as well as demand a tax on a 'mark up' fixed on an arm's length basis.

The apex court has clubbed various cases that involve companies such as Maruti Suzuki, Canon, Sony India, Daikin Air Conditioning, Reebok, Haier Appliances, Honda Siel Power Products, Bausch and Lomb Eyecare (India), Discover Communication India and Bose Corporation India, among others. The matter is expected to be heard on September 28 and 29.

"In business, every organisation competes by continually investing in making consumers aware and being loyal to its products and services. Whether it is within parameters of Indian tax law to assume that every Indian entity belonging to an MNC group, advertises products and services solely with a view to enhance the value of brands or other intellectual property owned by its overseas parent? If that's the case, does it always need a separate arm's length consideration for doing so? This question is now before the Supreme Court to adjudicate. Remember, being 'out of sight' of consumers, slowly leads to being 'out of mind' leading to diminishing sales and profitability, leading to lower taxes being paid," said Hitesh Gajaria, senior partner, KPMG India.

The case is being closely tracked by MNCs and corporate tax practitioners. Construing AMP as a 'service' could also bring it under the net of GST. "Unfortunately, AMP expense has become a highly contentious issue," said Sanjay Sanghvi, partner, Khaitan & Co. "Many legal and practical aspects need consideration here - such as, whether promoting the brand of foreign 'associated enterprise' is an 'international transaction' in the first place. Can one say the Indian arm or subsidiary does not need to spend any money for running and maximising its own (i.e, the Indian company's) business in India? ," said Sanghvi.

Transfer pricing is a business law and a lot would depend on the facts and business realities in each case. Consider a company with sales revenue of ₹500 crore, with manufacturing expenses of ₹300 crore and AMP of ₹100 crore. At present, the company pays tax on ₹100 crore (the pre-tax profit). If the I-T department has its way, a part of ₹100 crore - for some companies it could be almost the entire amount while for some it could be a large slice of AMP - cannot be considered as expenditure. Besides, the company has to fix a 'mark up' on an arm's length basis with its parent in accordance with the transfer pricing rules. Say, the mark up is ₹6 crore. Suppose, the ₹60 crore of AMP is disallowed as expenditure by the taxman. In such a situation, the company has to pay tax on ₹166 crore (100 plus 60 plus 6 crore instead of ₹100 crore (as is the practice now).

According to senior chartered accountant Dilip Lakhani, "The understanding or arrangement between the foreign parent and the Indian arm is very critical in deciding on the nature of advertising and the quantum of expenditure. Having decided this point of law, the Court may also frame guidelines and parameters to be followed for quantification. But as facts would differ from case to case, only time would tell whether it would provide a final answer."