The decision emphasizes the importance of functional, assets and risk analysis.
The taxpayer (an Indian subsidiary of a U.S. company) entered into a product replacement services agreement with its parent company. The U.S. parent company made direct sales to customers in India (along with warranties and annual maintenance agreements).
Under the product replacement services agreement, the taxpayer sourced spare parts from its U.S. parent company, and facilitated delivery of these parts to the customers of the U.S. company in India. The taxpayer was compensated with a mark-up on the “landed cost” of the imported spare parts and a mark-up on logistics, warehousing, and other costs incurred in providing these services.
The taxpayer defended its arm’s length position by selecting the Transactional Net Margin Method (TNMM) as the most appropriate method, with the comparables selected being logistic services providers.
The Transfer Pricing Officer, however, rejected the taxpayer’s transfer pricing study and re-characterized the taxpayer’s functional operations on the premise the taxpayer owned and purchased the imported spare parts and thus assumed the character of a distributor / trader with respect to the subsequent supply of the spare parts to customers.
In proposing a transfer pricing adjustment, the Transfer Pricing Officer selected companies engaged in the trading of electrical goods as comparables, and adopted the Resale Price Method (RPM) as the most appropriate method for determining the arm’s length price. The Dispute Resolution Panel upheld certain portions of the transfer pricing adjustment, but provided partial relief to the taxpayer.
The Bangalore tribunal concluded that:
- The taxpayer could not be characterized as a distributor / trader because it had no right to (1) fix the resale price or (2) choose the customer. The taxpayer merely acted as the custodian of the imported goods until the goods were delivered to customers, per the direction of the U.S. parent company.
- Because the taxpayer was not a distributor / trader, RPM was not an applicable method. Rather TNMM was appropriate.
The tribunal noted the importance of functional, assets, and risk (FAR) analysis in conducting the benchmarking exercise for selecting comparable companies.
Also, the tribunal observed that the services provided by the taxpayer were akin to those provided by clearing and forwarding agents (i.e., those responsible for safe-keeping and transporting goods to customers at the direction of the principal). Thus, the tribunal concluded that the comparables selected by the taxpayer were appropriate.
To read a June 2012 report, prepared by the KPMG member firm in India: Bangalore Tribunal upheld significance of functional, assets and risk analysis in the course of transfer pricing proceedings (PDF 212 KB)