Royalty arrangement: 25pc of sales promotion, ad expenses disallowed

ISLAMABAD: The government has disallowed 25 percent of sales promotion and advertising expenses under the royalty arrangement.

The proposal under the Finance Bill 2024 is to disallow 25 percent of sales promotion, advertisement and publicity expense if a deduction has been claimed on account of royalty paid or payable to an associate.

Explaining a key amendment in the Finance Bill 2024, tax expert informed that under the existing provisions, royalty payable to an associate is allowed as a deduction as long as the same is in accordance with the arm’s length principles.

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In case of a non-arm’s length transaction, the Commissioner is empowered to disallow an expense in the hands of payer if the same exceeds the arm’s length value of the transaction as determined in accordance with the prescribed methods.

There is no restriction on claim of sales promotion and advertisement expense in such arrangements.

Through a proposed amendment, 25 percent of the total expenditure on account of sales promotion, advertisement and publicity shall be disallowed and allocated to an associate with whom an arrangement for royalty on certain intangibles is in place and the amount of such royalty is claimed as a deduction in the current tax year or any of the preceding two tax years. This amendment is proposed to be applicable for tax year 2024 and onwards.

In case of the above arrangements with non-resident associates, such allocation of expense would not be ordinarily admissible to him as his royalty income would have been charged to final tax regime.

For non-residents protected by an applicable double tax treaty, it can be argued that no such allocation is permissible as long as the royalty itself is on arm’s length basis. Furthermore, the applicability of this proposed provision for tax year 2024 needs to be examined in the light of principles relating to past and closed transactions, tax expert added.

Another top expert was of the view that a new provision has been inserted whereby payments to associates on account of use of brand, logo etc will be disallowed to the extent of 25 percent.

There was no such provision in the past. The placement of the section is not correct. This provision effectively appears to be applicable to two preceding years from the tax year 2024. Retrospective effect is a subject to be examined, he added.

Copyright Business Recorder, 2024