The tribunal’s decision also addresses the treatment of reimbursement cost / pass-through costs for the purpose of mark-up, and acknowledges that economic adjustments are to be made in determining the arm’s length price.
The taxpayer was engaged in providing business process outsourcing services (e.g., contact centre, data entry, data processing, and related services) to foreign related parties.
For purposes of determining the arm’s length price of its international transactions, the taxpayer had undertaken a transfer pricing study and selected the Transactional Net Margin Method (TNMM) as the most appropriate method using operating profit on operating cost as a profit- level indicator. Under this analysis, the taxpayer concluded that its international transactions were at arm’s length.
The Transfer Pricing Officer, however, rejected the taxpayer’s transfer pricing study and instead conducted a fresh benchmarking analysis to arrive at an arm’s length price for the taxpayer’s business process outsourcing services provided to related parties.
In determining the taxpayer’s operating margin from the business process outsourcing services, the Transfer Pricing Officer included the value of re-imbursements in the cost base and also denied economic adjustments claimed by the taxpayer for the differences between the taxpayer’s profile and the profile of comparable companies identified by the Transfer Pricing Officer in terms of risk assumed and the depreciation policy adopted.
The tribunal held in favor of the taxpayer on certain comparable company issues, and held in favor of the tax authorities with respect to certain “filters” adopted by the Transfer Pricing Officer in selecting comparables.
The tribunal agreed with the taxpayer’s contention that some of the comparables may be undertaking market risks / entrepreneurial risks (which was not the taxpayer’s situation) and concluded that the tax authorities need to re-examine this issue.
Read a July 2013 report [PDF 214 KB] prepared by the KPMG member firm in India: Hyderabad tribunal adjudicates on principles of comparability analysis, treatment of reimbursement cost for purpose of mark-up and admissibility of economic adjustments
Contact a tax professional with KPMG's Global Transfer Pricing Services.