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Details

  • Service: Tax, Global Transfer Pricing Services, Global Compliance Management Services, International Tax
  • Type: Regulatory update
  • Date: 8/19/2014

India - Arm’s length price based on exports’ FOB value 

August 19: The Supreme Court of India has granted the tax authorities’ special leave petition against an order of the Delhi High Court, that had rejected an arm’s length price determination based on the FOB value of goods exported from India by third-party vendors to customers.

The case identifying information is: CIT v. Li & Fung India Pvt. Ltd. SLP No(s) 11346/2014.

Background

The taxpayer in India provided sourcing support services to its Hong Kong-based related entity, for which the taxpayer was paid remuneration of its costs plus a 5% mark-up.


The taxpayer applied the Transactional Net Margin Method (TNMM) to determine the arm’s length price of the remuneration, and determined that the profit level indicator was the operating profit / total cost.


The Transfer Pricing Officer accepted the TNMM as the most appropriate method of determining the arm’s length price and also accepted the comparables selected by the taxpayer, but determined that the cost for purposes of the 5% mark-up must include the “free on board” (FOB) value of the exports that were facilitated by the taxpayer.


The Dispute Resolution Panel basically agreed, but reduced the mark-up to 3% of the FOB value of exports.


A tribunal agreed with the Transfer Pricing Officer’s findings that the cost-plus mark-up methodology adopted by the taxpayer was not at arm’s length, but held that the amount of the transfer pricing adjustment cannot exceed the amount that had been retained by the related entity from the total remuneration received from third-party customers. The tribunal concluded that the distribution of the total compensation received by the related entity from its customers (5% of FOB value of exports) between the taxpayer and the related entity would be in a ratio of 80:20.

High Court’s finding

On appeal, the High Court of Delhi rejected the arm’s length price determination based on the FOB value of exports, finding that it was the related entity—and not the taxpayer—that undertook substantial functions and assumed enterprise risks and operational risks. The High Court’s decision, therefore, affirmed some basic principles relating to the application of the TNMM for purposes of determining the arm’s length price of sourcing support services transactions.


The decision of the High Court was viewed as providing guidance for taxpayers in low-risk and captive sourcing support services when the tax authorities might attempt to impute a commission on FOB value of the goods sourced from India.

Supreme Court to decide

The tax authorities appealed to the Supreme Court which has granted the tax authorities’ special leave petition against the High Court’s order.


With this action, prudent taxpayers would consider whether they have robust documentation in place—documentation supporting the low-risk nature of their transactions—if they had previously relied on the High Court’s judgment in this case, pending final resolution of the case by the Supreme Court.


Read an August 2014 report [PDF 456 KB] prepared by the KPMG member firm in India: The Supreme Court admitted Revenue’s Special Leave Petition against Delhi High Court’s order rejecting Arm’s Length Price determination based on Free On Board value of goods in the case of Li & Fung India Private Limited



Contact a tax professional with KPMG's Global Transfer Pricing Services.




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