The Indian Income Tax Act, 1961 has a dubious distinction – it is perhaps the most important legislation in the country that gets amended considerably, every single year. The last Budget for example, saw nearly a hundred amendments in the form of insertions of new sections, clarifications, provisos, explanations etc. Very often, these amendments are knee-jerk reactions to overturn the judgments of the highest courts of the land, with examples galore of court rulings resulting in the inevitable overhaul of the IT Act. The ultimate nadir was perhaps achieved in 2012, with a slew of amendments, retrospective and otherwise that were devised to overturn the Vodafone ruling by the Supreme Court. It is in this context that the Fosters [1] judgment by the Delhi HC assumes significance.

We will examine the Fosters case and why it is the perfect brew for the next amendment to the IT Act.

Facts:

Foster’s Australia was an Australian company that had a step down subsidiary in India viz., Foster’s India. Both the Indian and Australian entities were engaged in similar brewery businesses. In order to undertake its brewery business in India, Foster’s India had obtained the license to use the “Foster’s” trademark, owned by Foster’s Australia, under a Brand License Agreement (“BLA”). The licensed trademark continued to be owned by Foster’s Australia, with the Indian entity being a mere licensee.

Subsequently, Fosters Australia divested its Indian business, and the ownership of the step-down subsidiary was transferred at its Mauritius intermediary holding company level. Due to ownership transfer, the BLA was terminated and the license to use trademark also stood cancelled. Fosters Australia also transferred/assigned the trademarks owned by it to the buyer SAB Miller. In order to determine whether it has any tax liability in India upon transfer of the trademarks, Fosters Australia approached the Authority for Advance Rulings (“AAR”).

The AAR had at that time, held that since the trademark was used and exploited in India the transfer of the trademark owned by Fosters Australia to SAB Miller would result in tax implications in India. This would be so because since the trademark was being ‘exploited’ in India, it qualified as an asset “situated” in India.

Delhi HC’s observations:

Acknowledging that the question of situs of an intangible asset like trademark is tricky, the Delhi HC held that such assets do not exist in physical form in any particular location. The HC noted that the Indian legislature could have, through a deeming fiction, provided for the location of such intellectual property rights; but the Indian legislature had not done so. While the 2012 amendments to the IT Act amended the law with retrospective effect, it deals with only share or interest in a company outside India, deriving substantial value from its Indian assets. However, there is no equivalent provision with regard to intangible assets like trademarks and other intellectual property rights. Therefore, the well accepted principle of mobilia sequuntur personam i.e. situs of owner of intangible asset would be the closest approximation of situs of intangible asset, would have to be followed. Since the owner of the trademark i.e. Fosters Australia was not located in India at the time of the transaction, any income from transfer of the Fosters trademark will not be liable to tax in India.

An Amendment in the offing?

The Delhi HC has specifically noted that the legislature could have provided for a deeming fiction to tax income from intellectual property transfers. The key argument of the AAR had also been that since the trademark was “commercially exploited” in India, aided by marketing and advertising efforts by the Indian subsidiary, valuable intangible asset was created in India. The AAR’s finding was, however, negated by the Delhi HC.

Do marketing expenses incurred by the Indian licensee to sell the product in India mean that the licensee is actually the economic owner of the product’s trademark? Does this also mean that the trademark is located in India? In Sony Ericsson Mobile Communications [2], the Delhi HC had distinguished between brand building, and marketing and advertising expenditure. The Delhi HC had noted that many reputed brands incur marketing and advertisement expenditure not with the intention to increase brand value, but to increase sales and profits. Thus, while routine advertisement expenditure may not be a brand building exercise, if the brand is being exploited in India for the benefit of the foreign parent, there may be potential economic ownership of the brand in India. This, according to the Delhi HC must be determined factually, based on a detailed FAR [3] analysis.

So, should an amendment be introduced in the IT Act, the most interesting aspect will be the potential change, to the definition of a ‘capital asset’. Currently, the IT Act defines a “capital asset” as “property of any kind held by an assessee”. Since a limited use license is typically ridden with various restrictions and conditions, including restrictions on sub-licensing, one cannot help wondering whether under the current definition, a license to use a trademark will indeed qualify as a “capital asset”. It will also be interesting to understand how the computation/ attribution of capital gains arising on the transfer of a trademark abroad would be determined. Would the gains be dependent on a FAR analysis as per transfer pricing provisions as set out in Sony Ericsson? Or will there be a fixed formula to determine the gains? We’ll have to wait and see!