DIRECT TAX - Nangia & Co

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Tax & Regulatory Newsletter Issue 05 – AUGUST, 2010 NANGIA & CO. Chartered Accountants New Delhi – Mumbai - Dehradun Article 7(2) was relevant only for intra organization transactions or transactions with Associated Enterprises. Accordingly, the revenues earned by the taxpayer were to be taken at actual figures and no adjustments are permissible in the same; Further, Article 7 (1) provided for the taxability of profits “directly or indirectly attributable” to the PE. The words “profits indirectly attributable to the PE” incorporated the “force of attraction” principle. To give effect to the “force of attraction” principle, in addition to taxability of income in respect of services rendered by the PE in India, any income in respect of the services rendered to an Indian project, which were similar to the services rendered by the PE were also to be taxed in India in the hands of the taxpayer irrespective of whether such services were rendered through the PE or directly by the GE. There could not be any professional services rendered in India which were not, at least indirectly, attributable to carrying out professional work in India. This indirect attribution was enough to bring the income from such services within the ambit of taxability in India. Hence, the entire profits relating to services rendered by the taxpayer, whether in India or outside, in respect of Indian projects was taxable in India. [Source: ITA No. 4896 & 5085/Mum/03 dated July 17, 2010] Transfer Pricing Law for using foreign trademarks and advertisement Maruti Suzuki India Limited *“the taxpayer”+, an Indian company engaged in the business of manufacture and sale of automobiles, besides trading in spares and components of automotive vehicles entered into a License Agreement with Suzuki in the year 1992 for the manufacture and sale of certain models of Suzuki four wheel motor vehicles. As per the terms of the Agreement, Suzuki agreed to provide the necessary technical collaboration and licenses of the Suzuki products and parts and also granted exclusive right to use licensed information and the licensed trademark ‘Suzuki’. The Transfer Pricing Officer *“TPO”+ issued a notice to the taxpayer to determine the Arms Length Price of the international transactions between the taxpayer and Suzuki. The initial approach of the TPO was that there was a ‘deemed transfer’ of ‘Maruti’ brand name to Suzuki for which the taxpayer should receive an arm’s length consideration based on the fair market value of the brand (‘deemed transfer theory’). In the final order, the TPO abandoned the ‘deemed transfer theory’ and proposed to make an adjustment under the ‘assister in development theory’ wherein he disallowed the Royalty paid to Suzuki for use of trademark and the advertisement expenses incurred in promoting the ‘Suzuki’ trademark on the basis that the huge advertisement and promotional expenditure was made to develop a Page | 9
Tax & Regulatory Newsletter Issue 05 – AUGUST, 2010 NANGIA & CO. Chartered Accountants New Delhi – Mumbai - Dehradun market for the vehicles, which included promotion of the trademark ‘Suzuki’. The TPO relied on the OECD Transfer Pricing Guidelines relating to intangible property in support of the above theory. The US case law of DHL Inc. and Subsidiaries vs. Commissioner [TCM 1998-461] was also referred to in the order wherein the ‘bright-line’ test was advocated by the Court. The taxpayer challenging the order of the TPO filed a writ petition in the High Court. The High Court remanding the matter back to the TPO for a fresh adjudication ruling that – The onus was on a taxpayer to satisfy the TPO that the Arms Length Price was computed in consonance with the provisions of the law and the TPO could reject the price computed by the taxpayer and determine it only where he found that the taxpayer has not discharged the onus placed on it, or that the data used by the taxpayer was unreliable, incorrect or inappropriate, or there was certain evidence, which discredited the data used or the methodology adopted by the taxpayer. As the TPO had abandoned the ‘deemed transfer theory’, originally proposed in the notice in favor of the ‘assister in development theory’, in the final order, it was obligatory for him to issue a fresh notice for the change in approach for making the proposed adjustment; If a domestic entity, irrespective of whether it was an independent entity or an Associated Enterprise of a foreign entity, felt that the use of a foreign brand name and/or its logo was likely to be beneficial to it, there could be no dispute about the business decision to use the foreign brand or logo on payment of a royalty. However, in the case of Associated Enterprises, such royalty payment would have to satisfy the arm’s length test. There were valid business reasons for the taxpayer to enter into an agreement with Suzuki in order to meet the increased competition from foreign players. In such a case, the benefit from the association of a reputed name and logo may outweigh the loss, if any, in the value of the domestic brand. The test was to determine what a comparable entity, placed in the position of the taxpayer, would have done and only then could it be determined whether Suzuki had given any subsidy to the taxpayer in the payment of royalty or it got more than what it ought to have. The Tax Authority had not tried to find out what royalty, if any, a comparable independent entity would have paid for the benefits derived by the taxpayer under the Agreement; If a domestic Associate Enterprise uses a foreign trademark, no payment to the foreign entity on account of such user was necessary in case the user of the trademark was discretionary. However, the “income” arising from such transaction was required to be determined at arm‘s length price. If a domestic Associate Enterprise was mandatorily required to use the foreign trademark on its products, the foreign entity would have to make payment to the domestic entity on account of the benefit the foreign entity derives in the form of marketing intangibles from Page | 10
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