The taxpayer (an Indian firm engaged in manufacturing medical diagnostic imaging equipment) entered into international transactions and sold manufactured goods to foreign related entities.
In its transfer pricing study, the taxpayer adopted the Cost Plus Method as the most appropriate method for determining the arm’s length price and identified 19 comparable companies. The arithmetic mean of the comparable companies was 15.72% gross mark-up on costs, while the taxpayer had a margin of 16.24%.
On audit, however, the Transfer Pricing Officer rejected the comparables selected by the taxpayer (on the basis that certain comparables were manufacturers of automobile parts, and not in the taxpayer’s industry segment), and instead identified three new comparables. The Transfer Pricing Officer recomputed the arm’s length price factor at 44.53%, and made a transfer pricing adjustment of INR 596.5 million (approximately U.S. $9.6 million).
On administrative appeal, the taxpayer took the position that the Transaction Net Margin Method (TNMM) was the most appropriate method. The Commissioner of Income-tax (Appeals), however, found that since the taxpayer itself had considered the Cost Plus Method as the most appropriate method in its transfer pricing study, the taxpayer could not reverse this position. Still, the CIT(A) agreed with the taxpayer on the use of export turnover filter and directed the Transfer Pricing Officer to apply the filter of export revenues to operating revenues being more than 25% and to re-compute the arm’s length price.
Both parties applied to the tribunal.
The tribunal found that:
- India’s transfer pricing rules advocate the use of only one transfer pricing method as the most appropriate method.
- The taxpayer may subsequently change a method from one previously selected as the most appropriate method, but only if there were changes in the facts, functionalities or availability of data.
Looking to the UN Practical Transfer Pricing Manual for developing countries, which advocates the use of the Cost Plus Method for contract manufacturers, the tribunal agreed that this method was the most appropriate for the taxpayer in this case.
Read a February 2014 report [PDF 531 KB] prepared by the KPMG member firm in India: Bangalore Tribunal adjudicates on the most appropriate method for contract manufacturing
Contact a tax professional with KPMG's Global Transfer Pricing Services.