The tribunal returned the case to the Transfer Pricing Officer with instructions to determine the advertising, marketing, and sales promotion expenses after applying “proper comparables” and after noting that expenditures directly connected to sales could not be brought within the scope of advertising, marketing, and sales promotion expenses.
The taxpayer (an Indian company) manufactured passenger cars in India.
The taxpayer entered into a technical assistance and license agreement with a Japanese company. The license agreement granted the taxpayer the exclusive right to manufacture specific models of cars using licensed technology, know-how, and the Japanese company’s trademark.
The taxpayer used a co-branded trademark on the passenger cars it produced and sold in India.
The taxpayer paid a lump-sum royalty and a “running royalty” to the Japanese company under the license agreement.
Transfer pricing methods
In its transfer pricing documentation, the taxpayer selected the Transactional Net Margin Method (TNMM) as the most appropriate method and the Operating Profit / Sales Method to benchmark its various international transactions—including the royalty payment made to the Japanese company under the license agreement.
The taxpayer computed the Operating Profit / Sales at 11.9% (whereas the same was 4.04% for the comparables selected). Accordingly, the taxpayer concluded that its international transactions with related parties were at arm’s length.
The Transfer Pricing Officer, however:
- Made an adjustment by bifurcating the royalty payment made under the license agreement between (1) the use of technology and (2) the use of brand name
- Determined that a payment to the Japanese entity for the taxpayer’s use of a co-branded name was not warranted, given the market recognition that the taxpayer’s own brand had in India
There was no dispute concerning the portion of the royalty relating to technology.
The tribunal found that the royalty paid by the taxpayer was under a single, indivisible contract that provided an exclusive right and license for the taxpayer to manufacture and sell automobiles in India. Also, the tribunal explained that it was not appropriate for the revenue authorities to “split” the license agreement when the parties to the agreement had not themselves contemplated a split.
The tribunal then concluded that the primary intent of the license was a transfer of technology, and not trademark usage.
Thus, the case was remanded (remitted) to the Transfer Pricing Officer with instructions to determine the rate of advertising, marketing, and promotion expenses by applying proper comparables.
Read an August 2013 report [PDF 209 KB] prepared by the KPMG member firm in India: The Delhi Tribunal held TPO’s actions of splitting the composite royalty into technology royalty and trademark royalty as arbitrary
Contact a tax professional with KPMG's Global Transfer Pricing Services.