The taxpayer exports home and personal care products to its related entities, and in connection with these international transactions, paid advertising expenses to its foreign related entities and others.
The taxpayer adopted the Transactional Net Margin Method (TNMM) in its transfer pricing study as the most appropriate method for determining the arm’s length price. The taxpayer identified six comparable companies, for which the arithmetic mean was 8.08%, whereas the taxpayer had an entity-level operating margin of 47.17%.
The Transfer Pricing Officer accepted the taxpayer’s transactions—except for the payment of advertising expenses—as being at arm’s length. The Transfer Pricing Officer found that the taxpayer’s reimbursement of its related entities for advertising expenses at 20% of the expenses incurred by these entities was made without establishing a fixed basis on which the advertising expenses would be reimbursed.
The taxpayer countered that the advertising expenditure was an integral part of its successful export transactions, and the Commissioner of Income-tax (Appeals) agreed. The tax department filed this action before the tribunal.
The tribunal agreed with the CIT(A), and rejected the transfer pricing adjustment on advertising expenses reimbursed to the related entities. The tribunal followed a prior decision that advocated a transaction-by-transaction benchmarking approach and concluded that a “robust profit margin” of the taxpayer does not itself justify a higher advertising, marketing, and promotion expenditure.
Read a February 2014 report [PDF 393 KB] prepared by the KPMG member firm in India: Mumbai Tribunal deletes addition on export-related advertisement reimbursement
Contact a tax professional with KPMG's Global Transfer Pricing Services.