The taxpayer during the financial year 2005-06 provided sourcing support services to its Hong Kong-based related party. In return, the taxpayer received remuneration of its costs plus 5%.
The taxpayer applied the Transactional Net Margin Method (TNMM) to determine an arm’s length price for the remuneration, and used the “operating profit / total cost” as the profit-level indicator.
On examination, the Transfer Pricing Officer accepted that TNMM was the most appropriate method for determining the arm’s length price, and accepted the comparables selected by the taxpayer. However, the Transfer Pricing Officer determined that the “cost” (for purposes of the 5% markup) must include the FOB value of exports (i.e., exports of an Indian manufacturer to overseas third parties).
The Dispute Resolution Panel agreed with this determination, but reduced the markup to 3% of FOB value of exports.
The taxpayer first sought review by a tribunal, which generally affirmed the Transfer Pricing Officer’s findings that the cost-plus markup adopted by the taxpayer was not at arm’s length, and held that the transfer pricing adjustment cannot exceed the amount retained by a related party from total remuneration received from third-party customers.
The taxpayer appealed to the High Court, claiming that the cost-plus markup of 5% of FOB value of goods in transactions between third-party enterprises was not in compliance with India’s transfer pricing rules (i.e., that the rules contained no provision for considering costs incurred by third parties in computing the net profit margin of international transactions).
The High Court agreed with the taxpayer, holding that the transfer pricing rules do not provide for use of the FOB value of exports to determine the arm’s length price.
The decision affirms some basic principles related to the application of the TNMM for determining the arm’s length price in situations that concern sourcing of support services transactions.
Read a December 2013 report [PDF 467 KB] prepared by the KPMG member firm in India: The Delhi High Court allows the appeal in favour of the taxpayer by reversing the decision of the Tribunal in the case of Li & Fung India Private Limited. Holds TPO’s determination of the arm’s length price for sourcing support services based on markup on FOB value of exports contrary to the provisions of the law
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