The Delhi High Court held that the “Berry ratio” can be applied when the value of the goods is not directly linked to the quantum of profits, and the profits are mainly dependent on expenses incurred. The High Court thus explained that the Berry ratio can effectively be applied only in certain cases—such as in those involving “stripped-down distributors” because they have no financial exposure and risk in respect of the goods distributed by them.
The case is: Sumitomo Corporation India Pvt. Ltd. v. CIT
The taxpayer is an Indian subsidiary of one of Japan’s largest general trading companies (Sogo Shosha). The taxpayer entered into the following transactions:
In its transfer pricing report, these international transactions were benchmarked by the taxpayer on a combined basis. The taxpayer selected the Transactional Net Margin Method (TNMM) as the “most appropriate method” using the Berry ratio (gross profit to operating costs, as the profit level indicator).
For purposes of the Berry ratio, in computing the gross profit on the trading transactions, the taxpayer reduced the cost of sales from the aggregate value of sales made to its related parties and unrelated parties. This gross profit was then added to commission earned from indenting transactions to compute the total gross profit which was then divided by operating expenses to compute the Berry ratio. Using this calculation, the Berry ratio was computed at 1.79%. The weighted average profit level indicator of comparables was computed at 1.18%. Thus, the taxpayer determined the transactions were at arm's length.
The Transfer Pricing Officer, however, rejected the use of Berry ratio, and this was upheld by the Dispute Resolution Panel. The taxpayer sought judicial review, and in the initial review, the tax tribunal effectively agreed with the taxpayer’s position. The tax department sought review by the High Court which determined that the Transfer Pricing Officer’s decision to reject the Berry ratio could not be sustained.
In reaching its decision, the High Court looked to the application of the Berry ratio by U.S. courts, in U.S. regulations, in Japanese tax legislation, and in OECD guidelines. The High Court held that the Berry ratio can be applied when the value of the goods is not directly linked to the quantum of profits, and the profits are mainly dependent on the expenses incurred. Thus, as noted in the decision, the Berry ratio can effectively be applied only in certain cases—such as those involving “stripped-down distributors,” given they have no financial exposure and risk in respect of the goods distributed by them.
Read an August 2016 report [PDF 361 KB] prepared by the KPMG member firm in India: Berry ratio can only be applied in limited circumstances where value of the goods are not directly linked to the quantum of profits and the profits are mainly dependent on expenses incurred
<p>© 2018 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.</p>
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.