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India: No international transaction with related party, absent documentation

India: No international transaction with related party

The Mumbai Bench of the Income-tax Appellate Tribunal held that absent an arrangement or agreement with the foreign related party, the taxpayer was not required to undertake any “brand building” for the related party, and there was no “tangible evidence” to substantiate that advertising, marketing, and promotion expenses incurred by the taxpayer led to brand building or to the creation of marketing intangible that benefited the taxpayer group. The Transfer Pricing Officer cannot simply assume the existence of an international transaction merely on the basis of advertising, marketing, and promotion expenses incurred by the taxpayer without documentation to substantiate the presence of international transactions between the taxpayer and the related party.

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The tribunal further held that export benefits received from the government could be considered as operating income for calculating the margin for research and development (R&D) services rendered to the related party because the benefits received were connected to the R&D services rendered.

The case is: Colgate Palmolive (India) Ltd. v. ACIT (ITA No. 6073/Mum/2014 and ITA No. 2778/Mum/2011)

Background

The taxpayer was a 51% subsidiary of a U.S. corporation, and was engaged in manufacturing and marketing of diversified pharmaceutical products. 

The Transfer Pricing Officer examined the advertising, marketing, and promotion expenses and found that they were about 13% of sales (compared to an industry average of 6.39%), and that the royalty payment made by the taxpayer reflected steep growth from 0.15% in AY 1999-2000 to 0.96% in AY 2005-2006. Based on these findings, it was determined that sales on which a royalty was being paid reflected a “faster growth” benefiting the related party and that the advertising, marketing, and promotion expenses had to be shared by the related party.

The taxpayer asserted that the advertising, marketing, and promotion expenses were for the taxpayer’s business, and that there was no agreement with the related party for promoting the brand. The Transfer Pricing Officer rejected this contention, and apportioned the advertising, marketing, and promotion expenses using a ratio of royalty payment to total payment (that is, 0.96%) and made a transfer pricing assessment for additional income based on this determination. 

On administrative appeal, the transfer pricing assessment was “deleted” based on a finding that there was no direct benefit to the related party for the taxpayer’s advertising, marketing, and promotion expenses. It was at this point that the taxpayer asserted that the export benefits received from the government were in connection to the R&D expenses rendered to the related party and that these could be considered for margin calculation purposes.

The tax administration filed an appeal for judicial review by the tribunal.

Tribunal’s decision

The tribunal dismissed the tax administration’s appeal, and held that given that there was no arrangement or agreement between the taxpayer and the related party that obligated the taxpayer to undertake any brand building on behalf of the related party, no transfer pricing assessment could be made based simply on an assumption of the Transfer Pricing Officer.

The tribunal also agreed with the conclusion that the export benefits were inter-connected, were part and parcel of the export of the R&D services rendered by the taxpayer and could be considered as operating income for purposes of computing the margins from R&D activities.

 

Read a June 2018 report [PDF 559 KB] prepared by the KPMG member firm in India

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