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Corporate Feb 25, 2013

Why coming down on LG for ad spend is problematic

By Anant Rangaswami

"The income tax department has got a shot in the arm, with a special bench constituted by the Income Tax Appellate Tribunal (ITAT) ruling that consumer electronics major LG Electronics India is liable to pay tax on "excessive" advertising and marketing spends in the country, leading to notional benefits to its parent company," reports Business Standard.

"The tax department and the dispute resolution panel had earlier held that since the advertising expenses incurred by LG as a percentage of its sales were significantly higher than the expenses incurred by two comparable companies, it was promoting the brand owned by its foreign parent," the report added.

This is going to be a judgment that will be watched closely by all MNC brands operating in India.

How can IT assess a reasonable marketing spend/ Reuters

How can IT assess a reasonable marketing spend/ Reuters

At the heart of the issue, on a reading of the report, seems to be the assessment of what constitutes "excessive" spending on advertising and marketing.

The IT department case seems to be that, when compared to two other 'comparable' companies, LG's spend is significantly higher.

That's a tricky comparison. Who will decide what constitutes the right spend? What if these two other 'comparable companies' are underspending on advertising and marketing? What if their ambitions are set lower than LG's? What if they are happy to occupy, say, a number 3 or number 4 slot in the category, while LG wants to be the number one? What if LG is willing, thanks to increased spends in their advertising and marketing budgets, to lose money in India in the short term, while believing that these losses are investments in a bright future?

To decide based on comparisons is a weak argument. In any category, a new brand with aggressive ambitions might spend disproportionately higher on A&M than older incumbents based on the fact that the incumbents have, over the years, already built top-of-mind recall and brand salience. Is it the IT department's case that there should be broad similarity in spend ratios across a category?

In the current instance, the tribunal's ruling is on A&M spends. Can the 'comparison' argument be extended to, say, R&D, salaries, commissions, dealer margins?

At the most fundamental level, the IT department has no business in interfering with the business strategies of companies, which includes, certainly, deciding how much they should spend on any head of expense.

That the argument is flawed at the most basic level is brought out by the following: what if one of these two 'comparable' companies decides to increase the A&M spends to match LG's? Does this make the third company guilty of underspending on A&M?

by Anant Rangaswami

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