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India Transfer Pricing Update for Distributors

 

Sunnyvale, CA -- (ReleaseWire) -- 04/05/2012 -- In the case of Mastek Ltd., India’s Income Tax Appellate Tribunal (ITAT) upheld that Mastek’s (the taxpayer) UK subsidiary was not undertaking merely distributing activities and should be classified as a marketing service provider. The ITAT upheld the benchmarking used for transfer pricing purposes.

The ruling was delivered during February 2012 in the case of Mastek Ltd. v. ACIT (ITA No. 3120/Ahd/2010).

Facts of the Case: How to Benchmark for Transfer Pricing Purposes? The Taxpayer (Mastek Ltd) is an Indian software services company which many subsidiaries. It has a subsidiary in the United Kingdom, i.e. Mastek UK Ltd (Mastek UK), which in this case acted as a distributor to the Taxpayer's software products in the UK.

The Taxpayer named Mastek UK as a distributor for the purposes of Indian transfer pricing, benchmarked the return on sales earned by Mastek UK against returns earned by comparable distributors. Indian tax authorities contested the Taxpayer’s claim. They classified Mastek UK as a pure marketing service provider, and for the purpose of calculating transfer pricing, the tax payer compared the operating profit divided by the value added expenses against similar margins earned by other marketing service providers.

The taxpayer took the case to India’s Dispute Resolution Panel, which ruled in favor of the Tax Authorities. The Taxpayer then appealed before the ITAT.

The Issue: Is the Subsidiary a Distributor or Providing Marketing Services? The main issue before the ITAT was whether the Tax Authorities were right in terming the nature of services provided by Mastek UK as marketing activities thus affecting the benchmarking for transfer pricing purposes.

The Decision: What Benchmarking Holds? The ITAT ruled that Mastek UK should be treated as a distributor because:
- Mastek UK is not just a customer-facing entity but undertakes contract negotiations on behalf of the Taxpayer.
- Both the credit risk and the market risk was borne by Mastek UK
- As per the Organization for Economic Co-operation and Development (OECD)Transfer Pricing guidelines, functional comparability takes precedence over product comparability. The Taxpayer was accurate in considering Mastek UK as a "distributor".

According to ITAT’s statement, the return on sales was the correct benchmark for comparing the margin earned by distributors.

The case emphasizes that companies engaged in distribution and sales activities for their group entities should give due consideration to agreements, employee functions, remuneration and business strategies that may be scrutinized in transfer pricing related cases.

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