APRIL 22, 2020

By Devinder Bagia, Joint Partner and Ajay Sharma, Associate, Lakshmikumaran and Sridharan Attorneys

THE addition of expenses incurred by distribution companies of global MNCs on local Advertisement, Marketing and Promotion (hereinafter referred to as 'AMP') of imported goods to the import value has been a bone of contention amongst the assesses and Custom Authorities for quite some time now. The issue is on AMP expenditure incurred by importer for the trademarked goods imported under distribution agreement with seller.

While construing the general AMP clauses in the distribution agreements, particularly of trademarked goods, the Custom department has taking a view that they are incurred as a 'condition of sale' of imported goods and 'on behalf of' the foreign supplying entities and hence hit by Rule 10(1)(e) of the Custom Valuation (Determination of Value of Imported Goods) Rules, 2007 (hereinafter referred to as 'CVR'). On the other hand, the importers have been arguing that such AMP spends are legitimate post import expenses incurred by importers 'on their own behalf' for distribution of imported goods in India covered by specific exclusion under the interpretative note of Rule 3 of CVR and hence not addable under Rule 10(1)(e) of CVR.

While this issue has already reached the door steps of the Supreme Court in Civil Appeal No. 3877/2018 against the decision of CESTAT in the case of M/s Reebok India Company Vs. CC, Patparganj - 2018-TIOL-561-CESTAT-DEL], the final hearing of which is eagerly awaited. Meanwhile, a recent judgement by the division Bench of the CESTAT, Delhi in the matter of Adidas India Marketing Pvt. Ltd v. CC, Patparganj decided vide Final Order no. 50507/2020 dated 05.03.2020 - 2020-TIOL-604-CESTAT-DEL] has ignited the issue again and laid a much required jurisprudence in respect of the inclusion of the AMP by discussing the legal issues which were untouched till date.

Through this article, we will try and analyse the issue in the light of the recent judicial pronouncements of the CESTAT.

THE ISSUES INVOLVED

Section 14(1) provides that the value of the imported goods shall be the 'transaction value' i.e. the price actually paid or payable for the imported goods by the importer to the foreign seller for delivery at the time and place of import, subject to conditions and additions of payments for 'cost & services' specified in Rule 10 of CVR.

At the heart of the dispute has been the interpretation of Rule 10(1)(e) of the CVR. It provides as under:

'In determining the transaction value, there shall be added to the price actually paid or payable for the imported goods, all other payments actually made or to be made as a condition of sale of the imported goods, by the buyer to the seller, or by the buyer to a third party to satisfy an obligation of the seller to the extent that such payments are not included in the price actually paid or payable'

Further, in the context of first requirement of 'condition of sale of imported goods', the Interpretative notes to Rule 3 of the CVR provides that conditions relating to marketing of the imported goods shall not lead to rejection of transaction value. It further provides that value of AMP activities should not be added to the transaction value provided these expenses are incurred by the importer 'on his own account' even though by agreement with the seller. The meaning of 'own his own account' has been another bone of contention of importers with the department. The term 'own his own account' means expenses incurred and paid for by the buyer¹. When such expenses are incurred and paid for by the buyer on his own account as a principal and not as an agent / representative of the foreign seller, they cannot be construed as incurred 'on behalf of the seller' even if it indirectly benefits the seller by enhancing the visibility and sales of his goods and brand in India.

The second cumulative requirement of addition under Rule 10(1)(e) is that the payment should be made (i) by the buyer to the seller or (ii) by the buyer to a third person, to satisfy the obligation of the seller.

When a distribution entity (importer) contracts with an ad agency in India as a principal for itself and pays its agency fee, it cannot be said that the payment is made 'to a third party to satisfy the obligation of the seller' since there is no privity of contract between the ad agency and the seller.

The CESTAT, Delhi on the issue of AMP additions in the matter of M/s. Reebok India Company Supra, held against the importer. The CESTAT based its reasoning on certain clauses in the agreement which inter alia required the importer to spend 6% of total net invoiced sales in India on AMP activities. The CESTAT considered such spends as an obligation imposed on the importer by the seller and hence a 'condition of sale' of imported goods. Further Hon'ble CESTAT in this case also held that terms of the agreement were such that the seller (exporter) of the goods was controlling every aspect of promotion of goods in India and as such expenses were held to be made 'on behalf of the seller'. Thus, the AMP expenses were found to be incurred as a condition of sale on behalf of the seller for satisfying the obligation of the seller.

With due respect, the CESTAT in above case, failed to appreciate the significance of interpretative note to Rule 3 and the meaning of phrase 'on his own account' used therein. The CESTAT also failed to discuss the second but important requirement of payments being made 'to a third party to satisfy the obligation of the seller'. As stated above, the said decision of the CESTAT is now pending in decision before the Supreme Court.

RECENT PRONOUNCEMENT OF THE CESTAT

In the recent landmark judgement passed by the division bench of CESTAT Delhi in the matter of Adidas India supra, the CESTAT dealt with all the above issues and added to the much required jurisprudence on the issue of AMP additions under Rule 10(1)(e) of the CVR. In this case, Adidas India was engaged in importing and selling adidas brand products. Adidas India executed agreements with various sports personalities, clubs and associations for the marketing and promotional activities of the products, for which it paid certain amount to them. The Department sought to include these amounts paid by Adidas India to sport personalities and associations in the assessable value of goods imported by Adidas India by taking recourse to Rule 10(1)(e) of the CVR.

The CESTAT held that for making additions under Rule 10(1)(e), the payment has to be made not only as a condition to sale but also the payment should be made to discharge the obligation for which seller is indebted to the buyer or to the third parties. At para 19, the CESTAT finds:

19. …For the sake of convenience, rule 10(1)(e) can be broken up into two parts for the purpose of determining the transaction value by adding:

(a) such payments actually made or to be made as a condition of sale of the imported goods by the buyer to the seller to satisfy an obligation of the seller; Or

(b) such payment actually made or to be made as a condition of sale of the imported goods by the buyer to a third party to satisfy an obligation of the seller.

The CESTAT found in the case that there was nothing in the agreement clauses which obliged Adidas India to necessarily incur AMP spends in India. The agreement clauses merely granted exclusive rights to market the products and incur promotional spends. There was no legally enforceable right available to Adidas Germany to compel Adidas India in making promotional spends. Hence, such spends were held not to be a 'condition of sale' of imported goods.

The CESTAT also found from agreement clauses that the second necessary requirement that such payments should be made 'for discharge of the obligation of the seller to third parties' was also absent in the case. The payments to sports personalities, clubs and associations by Adidas India was to discharge its own obligations (on own account) and not the obligations of Adidas Germany. The 'discharge of the obligation of the seller of the goods' was held to mean payment in respect of any liability which belongs to or on the name of the seller. The decision of the CESTAT in respect of the discharge of the obligation of seller can be understood from the following example

Example: Seller of imported goods 'A' while exporting goods to 'B' in India also enters into an ad agency contract with a third-party ad agency 'C'. There will be discharge of the obligation if either of the following situation arises-

- 'A' asked 'B' to settle/write off a pre-existing debt owed by 'A' to 'B' in its books of account consequent upon the export of goods to 'B'; or

- consequent to import of goods, 'A' asked 'B' to pay the ad agency fee to 'C' which was contractually payable by 'A' to 'C'.

In abovementioned situations, the benefit flows to the seller of imported goods in form of settlement of his liability/obligation to a third party.

Notably, the Hon'ble CESTAT in Adidas India recorded at para 41 that in the matter of Reebok India, the earlier bench failed to properly examine the second requirement of Rule 10(1)(e) in the following words:

"41. …..Though the Bench did notice that the amount paid by the buyer to a third party should be paid to satisfy an obligation of the seller and in this context referred to the Interpretative Notes also, but the Bench failed to examine whether the seller was indebted to the third party, which obligation of the seller was being satisfied by the buyer…."

The Tribunal in Adidas India also relied upon the recent decision of division bench of the CESTAT in M/s Indo Rubber and Plastic Works vs CC, New Delhi reported at - 2020-TIOL-485-CESTAT-DEL and the decision of CESTAT in the case of M/s Giorgio Armani India Pvt Ltd Vs. CC, New Delhi, - 2018-TIOL-1521-CESTAT-DEL which was affirmed by Supreme court in its decision reported at - 2019-TIOL-363-SC-CUS.

CONCLUSION:

The decision in Adidas India supra has comprehensively dealt with many issues and comes as a much-required relief to the importers involved in distribution and marketing of trademarked goods in India. It may be added that before taking any final view on addition of AMP spends to the import value depends on the agreement clauses and arrangement which the importers enter into with their foreign sellers. In the light of this development, it will also be interesting to see the approach of the Custom Department while investigating further matters on the issue.

[The views expressed are strictly personal.]

¹ Chapter III of "Commentary on the GATT Customs Valuation Code" by Saul L. Sherman