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Determination of arm’s length price with respect to marketing intangibles
The Delhi High Court ("HC") has delivered a landmark judgment in the case of Maruti Suzuki India Limited ("MSIL" or "the taxpayer") which provides vital guidance for determining the arm's length price ("ALP") for developing marketing intangibles in India. Taxand India examines the new ruling.
The taxpayer, engaged in the business of manufacture and sale of automobiles, entered into a license agreement with its associated enterprise, Suzuki Motor Corporation ("SMC") for the manufacture and sale of automotive vehicles including certain new models. As per the terms of the agreement, MSIL agreed to pay a lump sum amount as well as a running royalty to SMC as consideration for technical assistance and license. MSIL started using the SMC logo in the front side of the cars and continued using the brand name 'Maruti', along-with the word 'Suzuki', on the rear side of the vehicles manufactured by it.
The Transfer pricing Officer ("TPO") held that SMC failed to compensate MSIL for use of its trademark 'Suzuki' which. according to the TPO, was then a weak brand in India; whereas 'Maruti' was a strong brand. The TPO also concluded that the co-branded trademark 'Maruti Suzuki' led to migration of the economic value embedded in the 'Maruti' trademark to the 'Suzuki' trademark for which no compensation was paid. The TPO held that SMC did not compensate MSIL for developing the marketing intangibles with large advertisement expenses, which benefitted SMC. The TPO observed that MSIL had higher advertisement expenditure compared to other comparable companies, The TPO carried out adjustments to MSIL's total income by disallowing 50 percent of royalty and a portion of advertisement expenditure, held to be excess expenditure.
MSIL contended that the use of SMC's trademark had helped MSIL in maintaining its market share in face of stiff competition from multinational brands, post de-licensing of automobile sector and that no additional benefit was passed on to SMC by MSIL using SMC's trademark. Further the additional benefit, if any, received by SMC was offset by way of a huge subsidy in the royalty charged by SMC. MSIL also stated that MSIL's average annual sales growth at 18 percent also justified the huge marketing expenditure.
The HC considered the valid business reasons for MSIL to use SMC's brand name and held that the approach adopted by the TPO was not correct. The HC ruled that if the use of the 'Suzuki' logo was at the discretion of the MSIL, SMC cannot be required to pay MSIL. However, if the usage was forced upon MSIL, SMC had to compensate MSIL, at an ALP for the market support services and the higher advertisement expenditure spent by MSIL. The HC further noted that if the advertisement expenditure was not excessive as compared to its competitors, SMC would not be required to compensate MSIL, even if the usage of the logo was mandatory. It also noted that any concession or subsidy obtained by MSIL from SMC, including by way of lower royalty payments, should also be considered in determining the ALP compensation. With these observations, the HC directed the TPO to be guided accordingly and consider the taxpayer's claims.
Marketing intangibles are also attracting greater focus on issues related to capital gains. It is noteworthy that the Authority for Advance Ruling ("AAR") had in the case of Foster Australia Ltd, while dealing with the capital gains arising from the transfer of a trademark registered outside India, held that the mark had become an inextricable component of Indian business due to its continuous use for more than a decade in India. It held that the commercial exploitation of the trade marks aided by the marketing and advertising efforts of Foster's India resulted in the creation of valuable intangible asset in India. AAR concluded that the trademark was located in India at the time of transfer and incidence of capital gains would arise in India, even if the mark was not registered in India.
This is a landmark decision on the issue of development of marketing intangibles for the overseas Associated Enterprises. Marketing intangibles are increasingly becoming an area of contention in Transfer Pricing audits.
In the light of the above aspects, this decision provides valuable guidelines on the adjustment from a Transfer Pricing perspective. With this decision, there is likely to be greater focus on joint venture agreements where mandatory use of trademark has been provided for.
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