The operations of the taxpayer (a wholly owned subsidiary of a Japanese corporation) primarily consisted of agency services provided on behalf of the Japanese parent corporation and other group member companies. The taxpayer acted as liaison between the various business departments of the group companies and their suppliers and customers in India.
For the year at issue, the taxpayer selected for its five international transactions the Transactional Net Margin Method (TNMM) with the operating profit / operating cost as the profit level indicator. For the international transactions, the taxpayer’s margin was 16.87% (compared to 13.81% for comparables based on multiple years’ data). Accordingly, the taxpayer claimed that its international transactions were at arm’s length.
Findings of the Transfer Pricing Officer
The Transfer Pricing Officer, however, determined that for one of the five transactions (the provision of agency and marketing support services) the taxpayer provided vital services to the related parties—services that were critical to the taxpayer’s sourcing services in India.
The Transfer Pricing Officer also found that the taxpayer made sizeable investments in exploring and analyzing the Indian market; and that the taxpayer developed unique intangibles that afforded an advantage to its related parties. Based in part on these findings, the Transfer Pricing Officer concluded that the taxpayer had not been adequately compensated by its related parties and that the Profit Split Method was required in order to determine the arm’s length price of the international transactions.
Alternatively, the Transfer Pricing Officer asserted that under the TNMM, the taxpayer was to be treated as a commission agent and, by applying a set of nine comparables, arrived at a mean margin of profit at 42.13% on cost.
Tribunal sets aside the adjustment
After analyzing the functions and risks of the taxpayer, and finding that the taxpayer acted as a service provider with minimal risks, the tribunal rejected the Transfer Pricing Officer’s contentions and set aside the transfer pricing adjustment.
The tribunal found that the taxpayer’s primary service was to act as a mediator, and that the taxpayer was adequately compensated with a fixed fee for this activity. The tribunal looked to a chart / table provided by the taxpayer, to the Transfer Pricing Officer, and that showed for each transaction, the taxpayer’s risk was minimal with “least capital” being employed.
Read a June 2014 report [PDF 446 KB] prepared by the KPMG member firm in India: Rejects the TPO’s approach of using a PSM for agency services; the taxpayer assumed minimal risk, performed limited functions
Contact a tax professional with KPMG's Global Transfer Pricing Services.