India - Average advertising expenses of comparable companies not arm’s length benchmark for taxpayer’s advertising expenses 

The tribunal also observed that the Comparable Uncontrolled Price (CUP) method used by the taxpayer, to benchmark reimbursements paid by the taxpayer for advertising expenses incurred by a related entity, could not be rejected without appropriate reasons.

Background

The taxpayer is engaged in the manufacture and export of pharmaceutical products.

The taxpayer reimbursed a related entity in Cyprus for advertising and marketing expenditures incurred by that related entity.

The Indian Transfer Pricing Officer compared the taxpayer’s advertising expenditures (60.33% of sales) with the average advertising expenses of the top 17 comparable pharmaceutical companies (10.66% of sales) in making a transfer pricing adjustment with respect to what were determined to be excessive advertising expenses. The Transfer Pricing Officer also determined that the Transactional Net Margin Method (TNMM) was the most appropriate method to benchmark the taxpayer’s reimbursement of the advertising expenses incurred by its associated entity in Cyprus.

The transfer pricing adjustment was reversed on an administrative appeal filed by the taxpayer. The tax administration sought judicial review by the tribunal.

Tribunal’s decision

The tribunal issued a taxpayer-favorable decision, finding among other items that:

• A transfer pricing method adopted by a taxpayer is not to be rejected without a cogent reason.
• The arithmetical mean of advertising expenses incurred by comparable companies cannot be considered to be an arm’s length benchmark for the taxpayer’s advertising expenses, and such a method is not TNMM as defined in India’s transfer pricing regulations. Moreover, the taxpayer’s overall profitability was observed to be greater than the average profitability of the 17 comparable pharmaceutical companies.
• Certain factors—such as the nature of the products, of the markets, and the advertisement period—were not considered by the Transfer Pricing Officer.

To read a May 2012 report on the case, prepared by the KPMG member firm in India: Mumbai tribunal held that average advertisement expenditure of the comparable companies cannot be considered as an arm’s length benchmark to disallow excess advertisement expenditure (PDF 198 KB)