Liquor company United Spirits Limited is likely to appeal against a ruling by the tax authority in southern Karnataka that it cannot claim expenses for surrogate advertising, which will likely have implications for scores of other alcohol and tobacco firms.

Issued in the state capital, Bangalore, the ruling only relates to USL’s expenses for the 2015-16 tax year, but has set a precedent that will be closely watched in business circles. It affects a Rs3.2 billion (US$46.6 million) of advertising and will mean an increased tax liability of Rs1 billion (US$14.4 million).

“By the fundamental matching principle, a company cannot claim deduction on expenses not related to its business sales,” the order states.

Like other manufacturers, USL uses surrogate advertising to skirt India’s strict rules against the promotion of alcohol and tobacco products. This usually means that the names of prohibited goods are used for non-related products or marketing campaigns to keep them in the public eye.

The world’s second biggest alcohol manufacturer, with products like Antiquity and Bagpiper whiskeys, USL has been served with a revised notice to pay Rs6.7 billion (US$96.7 million) in tax for 2015-16. It is expected that an appeal will be lodged.

Experts say that if the ruling is upheld, earnings of the lucrative brewery and tobacco industries could take a big hit at a time when they are under intense pressure from authorities. New laws have also been issued by the Food Safety and Standards Authority of India requiring health warnings on alcohol bottles, which took effect on April 1.

Some experts are unconvinced

India’s brewing industry is the third largest in the world, with a value of US$35 billion, and had compound annual growth of 8.8% in 2018. The tobacco market is worth about $11 billion.

Industry leader USL had a capitalization of Rs401.8 billion (US$5.8 billion) as on April 1. The company reported sales of Rs185.9 billion (US$2.6 billion) in 2015-16, the year chosen for the tax reassessment; this figure includes spending on advertisements.

B S Venkatesh, a Bangalore-based chartered accountant, said the ruling indicated that the state tax department was concerned by both the “legal aspects” of USL’s activities and the nature of the expenditure.

“What they really look at is if it is a revenue expenditure or a capital expenditure and if it is related to the business. If it considers the legal aspects at all, it will scrutinize an expenditure which is prohibited by law,” he said, adding that such an expenditure would not be considered “deductible”  from taxable income due to its illegal status.

The tax report stated that USL had spent around Rs1.8 billion (US$25.9 million) marketing water, soda, sparkling water, music CDs, experiences and get-togethers, while not actually selling any of these products or services. USL gave third parties the licensing rights to sell McDowell’s No 1 water and soda, while charging a royalty of Rs40 million (US$577,489) for the use of its brand name.

Tax officials observed that the company does not receive any royalty for the sale of music CDs, experiences and get-togethers. The department found this “peculiar”, noting that it was unclear where the revenue to promote such activities was sourced and how it related to the business of USL. It suggested that this was a practise of surrogate advertising.

Sponsorship payments queried

USL had also contended that it made sponsorship payments of Rs1.6 billion (US$23.1 million), for total of Rs3.4 billion ($49 million), which must be considered revenue expenditure. However, they could only be regarded as such if the company did not receive any benefits in return.

The company claimed the amount as a revenue expense, but tax authorities said that expenses incurred for advertisements were “non-allowable” because USL was not selling its own products.

Alok Prasanna, a senior resident fellow at Vidhi Centre for Legal Policy and an advocate, said that the tax department was justified in saying this was a capital expenditure and not a revenue expenditure. “Because, if you own a liquor company, you cannot advertise it as per the law,” he pointed out.

Surrogate advertising emerged after the promotion of alcohol, liquor, wine, cigarettes, tobacco products or similar goods was banned under the Cable Television Networks (Regulation) Act of 1995. The act was amended in September 2000 to make it easier for companies, especially in the liquor and tobacco industries, to promote and advertise their brand names through surrogacy.

A government notification issued on February 25, 2008 stated that surrogate advertising by liquor companies in any form of media would be banned, but the Ministry of Information and Broadcasting issued a notification almost a year later amending the law. Any item with the same name as a liquor or tobacco product can be advertised as long as it does not depict the proscribed product.

Arjun MB, a chartered accountant, described the tax department’s refusal to accept the advertising and sponsorship expenses while still taxing the company as “tax terrorism”, noting that the law does not prohibit a company from advertising such products as soda water, sparkling water and CDs.

‘Tax terrorism’ decried

“Once I franchise (my) brand name, anything that is sold in the market is mine. It does not matter whether I, as a company, manufacture it, or someone else is manufacturing it, because the product is sold in my name,” he said. Arjun argued that since the product is being sold under USL’s brand name, it has the right to advertise, and this must be considered revenue expenditure.

Sri Sridhar B, the chief digital officer of USL, said in a statement that consumers of liquor are not targeted through their ad campaigns, an assertion also made by vice-president Abhishek Shahbadi. The tax department said that if this is the case, the expenses are definitely not allowable.

Shahbadi stated that he devotes 50% of his time to developing ad campaigns for non-alcoholic products that the company does not really sell. The tax department observed in its report that Shahbadi’s own bonus and incentives were linked to an increase in sales of liquor products and not to the non-alcoholic products, for which there were not even measurable targets.

“When you are promoting something which is not even a part of your business but carries your brand name or logo, what you are trying to do is to develop a long-term brand value,” Prasanna said.

The report also stated that the tax department had sought details on revenue that USL was earning from “experiences” and “get-togethers”, but the company had not furnished any.

Asia Times contacted USL and the Bangalore office of the tax department for comment, but received no response.