India: Most appropriate method, under cost contribution agreement

India: Method under cost contribution agreement

The Bangalore Bench of Income-tax Appellate Tribunal held that concerning payments for intragroup services related to technical and management costs, as expense transactions having no mark-up, the profit method may not be the most appropriate method. The tribunal remanded the case for an evaluation of a combined transaction approach vis-à-vis the Comparable Uncontrolled Price (CUP) method.

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The case is: Fosroc Chemicals India Pvt. Ltd. v. DCIT.

Summary

The taxpayer, a member of a multinational group and a subsidiary of a UK entity, was a manufacturer and distributor of specialty construction chemicals.

Technical know-how was provided to the taxpayer by the UK entity, and the taxpayer paid for the technical and management services provided by the UK entity under the cost contribution agreement. The taxpayer also purchased raw materials and entered into other transactions with its international related parties. The taxpayer selected the Transactional Net Margin Method (TNMM) at the enterprise level, on considering that the technical and management services were integral to the primary business segment of the taxpayer.

The Transfer Pricing Officer rejected the methodology adopted by the taxpayer for the technical and management costs; asserted that these costs were independent transactions that had to be considered under the CUP method; and eventually determined the arm’s length price was “nil” by applying the CUP method, and adjusted the full amount of the payment made for technical and management services.

On administrative appeal, the Dispute Resolution Panel took the position that the separate transactions were to be benchmarked on a stand-alone basis, unless they were closely interlinked and that this position justified application of the CUP method.

The issues before the tribunal were: (1) whether the Transfer Pricing Officer was justified in finding a nil arm’s length price, by consider CUP as the most appropriate method; and (2) absent data for applying the CUP method, whether application of the TNMM at the entity level was the proper approach.

The tribunal stated that when expenses are actually reimbursed with no mark-up, it is appropriate to determine whether costs claimed to have been apportioned among various group entities have not been inflated and are properly allocated.

The tribunal agreed with an approach of aggregating all international transactions, provided that the taxpayer was able to establish that different segments benefited from the services received from the related parties. The tribunal returned the case to the Transfer Pricing Officer for a determination on the approach to be adopted after evaluating the evidence and explanation provided by the taxpayer.

 

Read a May 2015 report [PDF 371 KB] prepared by the KPMG member firm in India: Profit methods may not be the Most Appropriate Method for intra-group services which are in the nature of expense transactions; Filing of voluminous correspondence, reports insufficient to discharge 'benefit' test

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