Bombay High Court confirms use of Resale Price Method in
Transcription
Bombay High Court confirms use of Resale Price Method in
KPMG FLASH NEWS KPMG IN INDIA Bombay High Court confirms use of Resale Price Method in case of distributors where there is no value addition to goods resold 18 November 2014 Background Facts of the case Recently, the Bombay High Court (the High Court), in 1 case of L’Oreal India Pvt. Ltd. (the taxpayer) upheld the ruling given by the Mumbai Bench of the Incometax Appellate Tribunal (the Tribunal) accepting Resale Price Method (RPM) over Transaction Net Margin Method (TNMM) for determining Arm’s Length Price (ALP) of L’Oreal India’s international transaction in respect of its distribution activity. The High Court dismissed the tax department’s contention that TNMM ought to have been applied in the case of the taxpayer, as the taxpayer had spent huge sums on selling and distribution of products, and hence there was a substantial value addition to the goods sold due to which RPM cannot be applied to determine ALP. Moreover, the High Court observed that since RPM was accepted by the Transfer Pricing Officer (TPO) in the preceding as well as the succeeding years in the taxpayer’s case, the Tribunal did not err in allowing the taxpayer’s appeal. The taxpayer is a company incorporated in India and engaged in the business of manufacture and distribution of cosmetics and beauty products. The taxpayer had divided its business into two segments viz. (i) manufacture and (ii) distribution. The TPO, proposed an adjustment by applying TNMM to international transactions related to the distribution segment and rejected the RPM adopted by the taxpayer, on the grounds that the taxpayer’s pricing policy is not at arm’s length since it is consistently incurring losses. The TPO also observed that the comparable’s gross margins cannot be relied upon because of product differences, and that the function, asset and risk (FAR) comparison of the taxpayer vis-à-vis comparable companies is sufficient only for application of TNMM and not RPM. The Commissioner of Income-tax (Appeals) [CIT(A)] deleted the entire addition made by the TPO after considering the taxpayer’s contentions, ___________ 1 CIT v. L’Oreal India P. Ltd. (ITA No. 1046 of 2012, dated 7 November 2014) – Taxsutra.com © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. and reliance was placed on the Organisation for Economic Co-Operation and Development (OECD) 2 guidelines and guidance note issued by The Institute of Chartered Accountants Of India (ICAI). The Tribunal agreed with the CIT(A) that there is no order of priority of methods to determine ALP. The Tribunal observed that RPM, being one of the standard methods, is the most appropriate method for distributing and marketing activities when the goods are purchased from Associated Enterprises (AEs) and resold to unrelated parties. The Tribunal also noted that this view was supported by OECD guidelines. The Tribunal observed that there is no doubt that the taxpayer buys products from its AEs and sells to unrelated parties without any further processing. Further, the taxpayer also produced certificates from its AEs that margin earned by AEs on supplies to the taxpayer was in the range of 2 to 4 per cent or even less. These certificates were not disputed by tax department. Accordingly, the Tribunal, while upholding the order of the CIT(A), observed that the TPO himself has accepted the RPM method in the preceding as well as succeeding assessment years in reference to the distribution activity of the taxpayer. Aggrieved, the tax department preferred an appeal before the High Court. Tax department’s contentions The TPO was justified in holding that RPM was not an appropriate method because the taxpayer had incurred a huge expense in selling and distribution, and the value of the goods originally transferred to the taxpayer and the contribution to the value of the final product sold cannot be evaluated. Taxpayer’s contentions The taxpayer contented that questions of law cannot be termed as substantial because in the taxpayer’s own case, RPM was accepted in the subsequent as well as previous assessment years. Incurring of the selling and distribution expenses in marketing which are required for the purposes of establishing the taxpayer’s presence in the local or domestic market would not make any difference, so as to reject the RPM. The taxpayer has been following a market penetration strategy since the commencement of its distribution business in 2001, and the comparables had presence in the Indian market since 1980s and early 1990s, having established themselves. The overseas AEs of the taxpayer confirmed that they earned only 2 to 4 per cent margins or even less, and thus the TPO’s contention that the goods are purchased from the AEs at higher price is not justified. The taxpayer relied on the order passed by the High Court in the taxpayer’s own case. High Court’s ruling The main grounds before the High Court and its verdict are as under: The High Court relied on the finding of the Tribunal that the TPO has accepted this method in the previous as well as succeeding assessment years in respect of the distribution activity of the taxpayer. Further, since no distinguishing features were noted, the Tribunal did not err in holding that RPM was the most appropriate method for determining ALP in respect of imports of finished goods. The tax department contended that of the two segments of the taxpayer viz. manufacturing and distribution, the TPO proposed an adjustment only with respect to the distribution segment because of the following reasons: The taxpayer’s consistent losses reflecting a nonarm’s length pricing policy Unreliable gross margin in case of comparable cases because of the product differences Need for the taxpayer to incur several expenses including promotional and advertising. Whether the Tribunal erred in holding that RPM was the most appropriate method for determining ALP in respect of imports of finished goods Whether the Tribunal erred in not appreciating that the substantial value addition made to the goods has changed the degree of similarity in the functions performed thereby making RPM non applicable in the instant case _____________ 2 As per OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued in July 2010 © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. KPMG FLASH NEWS KPMG IN INDIA The High Court observed that the Tribunal, in its order, has noted that RPM can be adopted in case of distribution or marketing activities when the goods are purchased from associated entities and there are sales effected to unrelated parties without any further processing. The same view is also supported by OECD guidelines and accordingly, the Tribunal did not err in holding that RPM is the most appropriate method for the international transactions in respect of import of finished goods. Our comments The ruling provides an important guidance in the application of RPM in case of transactions involving distribution activities. It re-emphasis that, though significant selling and distribution expenses are incurred, if there is no value addition to the products resold, RPM is the most appropriate method. Another important observation by the High Court is that there is no order of priority of methods and RPM is one of the standard methods and is to be used in case of distribution and marketing activities. Further, it observed that AEs that supplied to the taxpayer earned only 2 to 4 per cent margins hence it could not be said that there is a shift of profits by the taxpayer to its AEs overseas. This ruling provides an influential precedence for use of RPM method in cases of distributors that incur losses, on account of overheads in the initial years of market penetration. It also supports the view, that all the losses cannot be attributed to non-arm’s length dealings with overseas AEs. In fact good recovery in subsequent years and demonstration of non-shifting of profits to AE’s act as a corroborating evidence to support arm’s length dealings. © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. 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