The taxpayer imports “completely built units” of motor vehicles, spare parts, and accessories from foreign related parties, for resale in India. The taxpayer also assembles “completely knocked down” kits of certain products, again imported from related parties for resale in India.
The subject assessment year was the taxpayer’s first full year of operations.
The taxpayer entered into an import agreement with its ultimate holding company (a German entity). The agreement provides that by allowing the taxpayer to import and distribute the motor vehicle products in India, the taxpayer was responsible for establishing and supervising an efficient distribution network and for performing advertising, sales promotion, and public and media relations in India.
Transfer pricing documentation
In its transfer pricing documentation, the taxpayer characterized itself as a distributor, and also reported that it was performing low-value added assembly functions.
The taxpayer selected the Resale Price Method (RPM) as its primary transfer pricing method, and the Transactional Net Margin Method (TNMM) as its secondary method to establish the arm’s length nature of its international transactions.
- Under RPM, the taxpayer’s gross profit / sales ratio was computed to be 27.36% (compared to 13.65% of comparable companies).
- Under TNMM, the taxpayer’s operating profit / sales ratio was computed to be 13.52% (compared to 2.11% of comparables).
The Transfer Pricing Officer made an adjustment for “excessive” advertising, marketing, and promotion expenses, using the “bright-line test”—i.e., those amounts over the bright line represented brand promotion services provided by the taxpayer to its foreign related party. Thus, it was asserted the taxpayer must be compensated for this excessive amount (as recomputed) along with a mark-up of 15%.
The tribunal found, among other items, that the taxpayer had performed “greater intensity of services” than a normal distributor and that the advertising, marketing, and promotion activities provided by the taxpayer contributed to the “brand building” for the related party.
As the tribunal observed, brand building for a related party is an international transaction and that the “bright line test” was an accepted method for calculating non-routine advertising, marketing, and promotion expenses.
The tribunal, however, concluded that no additional compensation / payment was required from the related party, given that the premium profits earned by the taxpayer demonstrated that the compensation for the higher marketing services had been embedded in the pricing arrangement of the imported goods.
Tax professionals in India have observed that the tribunal distinguished the advertising, marketing, and promotion expense issue involving a distributor from that involving a licensed manufacturer. The case also clarifies how the typical advertising, marketing and promotion issue for distributors is to be analyzed.
Read an August 2013 report [PDF 460 KB] prepared by the KPMG member firm in India: The Delhi Tribunal held that premium profits earned by distributor are adequate compensation for excessive AMP, and deletes adjustment
Contact a tax professional with KPMG's Global Transfer Pricing Services.