India: Application of Berry ratio, transfer pricing methodology

India: Application of Berry ratio, methodology

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.

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The case is: Sumitomo Corporation India Pvt. Ltd. v. CIT 

Summary

The taxpayer is an Indian subsidiary of one of Japan’s largest general trading companies (Sogo Shosha). The taxpayer entered into the following transactions:

  • The purchase and sale of goods (trading transactions) with the purchase and sale being back-to-back transactions, and title to goods acquired only briefly (“flash title”) 
  • The provision of support services (indenting transactions), whereby goods are supplied directly by the supplier to the purchaser with its related parties

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

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