Transfer Pricing

CA. Bhavesh Dedhia, CA. Shazia Khatri

ITAT Quashes Transfer Pricing Adjustment on Re-characterization of Netflix India’s Role - Netflix Entertainment Services India LLP (ITA No. 6857/Mum/2024)

Key Facts

  • Netflix India claims itself as a limited-risk distributor of access to the global Netflix Service in India. It was remunerated on fixed profit margin (1.36% on sales for the relevant year). Netflix India benchmarked the said transaction using TNMM.

  • The TPO rejected the limited-risk distributor characterization. He re-characterized Netflix India as an independent entrepreneur and the principal service provider of content and platform in India, bearing significant entrepreneurial risks.

  • Accordingly, the TPO rejected TNMM citing inappropriate method for the complex, integrated media business. The TPO Adopted the “Other Method” under Rule 10AB. Determined the Arm’s Length Price (ALP) by attributing 43 percent of subscription revenue to Netflix India.

  • The DRP substantially endorsed and affirmed the TPO’s findings and re-characterization. Further, proposed an ad-hoc alternative corroborative benchmarking by arbitrarily attributing margins to various functional clusters.

Taxpayer’s Position

  • Netflix India operated as a limited-risk distributor to provide access to the Netflix Service in India.

  • Performs routine functions: marketing support, invoicing, customer service, and regulatory compliance.

  • No ownership or licence of content or technology; all IP remains with overseas AEs.

  • Costs fully reimbursed by AEs with a fixed Return on Sales (ROS) of 1.36%, ensuring risk insulation.

Tax Authorities’ Position (TPO & DRP)

  • Recharacterized Netflix India as a full-fledged entrepreneurial entity providing content and technology.

  • Alleged acquisition of content and platform on licence; proposed royalty-based ALP.

  • Adopted “Other Method” under Rule 10AB using third-party royalty agreements.

  • Computed royalty at 57.12% of revenue, leading to TP adjustment of Rs 444.93 crores.

  • Emphasised ownership of Open Connect Appliances (OCAs) and ISP arrangements as evidence of significant technological role.

Tribunal’s Conclusion

The ITAT examined the Distribution Agreement and noted following with respect to functions, assets and risk analysis of Netflix India:

  • Tangible assets comprise office premises, IT equipment, and OCAs whose function is logistical;

  • Its intangible assets are nil;

  • Its risks are limited to routine operational and regulatory exposures, all fully indemnified by the AEs;

  • It earns a Return on Sales (ROS) of 1.36 percent on a fully cost-insulated basis, consistent with a low-risk distributor profile

  • Employee strength (64 in India versus 9,400 globally) and roles (predominantly marketing, administration, and compliance) demonstrate a purely supportive function, not IP creation.

  • Total assets are approximately Rs 75 crores (≈USD 1 million), while Netflix US’s assets exceed USD 3,928 crores about 4,000 times larger. Content assets form the predominant share of the group’s balance sheet; Netflix India holds none.

The ITAT deleted TP adjustment of Rs 444.93 crores and held following:

  • Rejected recharacterization; held Netflix India is a limited-risk distributor.

  • No transfer of IP rights; OCAs are logistical tools, not core technology assets.

  • “Other Method” and DRP’s attribution model declared unsustainable in law and fact.

  • “To attribute 43% of global subscription revenue to an entity that neither owns nor develops the underlying content or technology is to violate the symmetry between function, asset, and risk the triad that defines economic ownership”

Key Point: ITAT reaffirmed that mere local infrastructure or customer-facing functions do not confer entrepreneurial status or justify royalty-based benchmarking absent IP ownership or DEMPE functions.

ITAT Upholds TPO’s reference from technical unit in Faceless Regime but Remands Issue of Operating Income for Re-computation - Sankalp Semiconductor Private Limited vs. DCIT (IT (TP) No. 1564/ Bang/2024)

Key Facts

  • The Assessee is primarily engaged in providing a range of design services for the semiconductor industry.

  • The TPO, upon examining the Assessee’s Transfer Pricing Study Report (TPSR), reclassified the international transaction from ‘Provision of IT Services’ (as claimed by the Assessee) to ‘Engineering & Design Services’. Based on this reclassification, the TPO rejected the Assessee’s comparables and carried out a fresh search to determine the Arm’s Length Price (ALP). The TPO also recomputed the Assessee’s Operating Profit/Operating Cost (OP/OC) margin to 12.06% (before final adjustment) by treating certain one-time bonus and Employee Stock Option Plan (ESOP) costs as operating expenditure.

  • The DRP largely upheld the order of the TPO.

Arguments of Taxpayer

  • The taxpayer challenged the validity of the final assessment order, arguing it was time-barred because the reference made to the TPO was invalid. The Assessee contended that under the Faceless Assessment Scheme (Section 144B), the reference was received by the TPO from the “AO Technical Unit”. They argued that the Technical Unit is only authorized to provide technical assistance and advice, and it cannot delegate or make a reference to the TPO itself, rendering the entire TP process void.

  • The Assessee objected to the TPO/DRP treating extraordinary/exceptional bonuses and the unvested portion of the ESOP expense as operating costs. The Assessee claimed these were non-operating, extraordinary expenses resulting from the company’s acquisition by HCL Technologies Ltd.

  • The Assessee also objected to the comparable companies selected by the TPO. This being fact specific is not discussed further in this summary.

Arguments of Department

  • The Revenue asserted that there was complete compliance with the Act and the Faceless Scheme. The Assessment Unit made the proposal for TPO reference, which was duly approved by the CIT (Assessment Unit). The Technical Assistance Unit merely forwarded this proposal to the Technical Unit/TPO. The Revenue also cited an identical jurisdictional issue dismissed by the Coordinate Bench in the case of Ucweb Mobile Private Limited (ITA 3945/DEL/2024).

  • The TPO treated the ESOP provision for unvested shares and the bonus payment as operating expenditure, noting they were staff costs based on accounting and disclosures. Since this practice was consistently followed, it could not be considered extraordinary.

Decision of ITAT

  • The Tribunal dismissed the Assessee’s jurisdictional ground on the validity of the TPO reference. The Tribunal primarily relied on the decision of its Coordinate Bench in Ucweb Mobile Private Limited (supra). It reasoned that under the Faceless Assessment Scheme, the Technical Unit’s role includes providing technical assistance and advice on transfer pricing issues. In performing this function, the Technical Unit is authorized to obtain expert advice and assistance from the TPO. Therefore, the reference made by the Technical Unit to the TPO was held to be valid and in accordance with the provisions of the Act.

  • The Tribunal upheld the TPO’s treatment of the ESOP provision and bonus as operating expenditure. The Tribunal held that since these expenses are recorded as staff costs in the books of accounts and are provided for according to the consistently followed accounting practices and policies disclosed in the notes on accounts, they are considered normal operating expenditure.

  • ITAT remanded the case to TPO to recompute the arm’s length price basis the directions given.

ITAT upholds NIL corporate Guarantee commission considering facts and circumstances of the case - Precision Camshafts Limited (ITA No. 2744/PUN/2024)

Key Facts

  • Precision Camshafts Limited is engaged in manufacturing camshafts.

  • The Assessee provided a Corporate Guarantee to the Bank of Baroda (BOB), London, on behalf of its AE, charging NIL commission, as explicitly restricted by a covenant in the guarantee deed with the bank.

  • The Assessee provided a cash advance facility/loan to its AE to repay a loan taken from BOB, charging interest at 1.9% (the same rate charged by BOB-London).

  • The TPO proposed a TP adjustment on the international transaction of providing a corporate guarantee by the Assessee. The TPO arrived at this figure by applying a 0.5% commission rate, relying on the Bombay High Court’s decision in the case of Everest Kanto Cylinders Ltd. (ITA No. 1165 of 2013).

  • Further, on cash advance facility, the TPO argued that the 1.9% rate was low because of the corporate guarantee, and therefore, proposed a protective addition by adding a 0.5% mark-up (for risk mitigation) to the 1.9% rate.

ITAT decision

Corporate Guarantee commission

  • The Tribunal noted that the issue was covered in the Assessee’s favour by the Tribunal’s own decision in the Assessee’s case for the immediately preceding Assessment Year (A.Y. 2020-21).

  • In the earlier year’s order, it was noted that the Bank of Baroda (BOB) had imposed a specific condition in the corporate guarantee deed that the Guarantor (the Assessee) shall not receive any commission from the borrower (the subsidiary).

  • The Tribunal, following an ITAT Mumbai decision on an identical issue, held that since the non-charging of the commission was pursuant to conditions stipulated by the independent sanctioning bank (BOB), no addition for guarantee commission was called for.

  • The Tribunal also distinguished the Everest Kanto case (supra) noting that in that case, there was no condition imposed by the lending bank (ICICI Bank) that prevented the charging of a guarantee commission, which made the facts different from the Assessee’s case.

Interest on Cash Advance Facility

  • The Tribunal considered the Assessee’s argument that the TPO did not provide any basis for the ad-hoc 0.5% mark-up and had not adopted any of the prescribed methods for determining the Arm’s Length Price (ALP).

  • Following the ITAT Pune decision in Rehau Polymers Pvt. Ltd. (ITA 658/PUN/2022) and Bombay High Court decisions, the Tribunal reiterated that a TP adjustment is not sustainable in law if the TPO has not adopted any of the prescribed methods for ALP determination.

    • Bombay High Court Rejects Revenue’s Appeal on Transfer Pricing; Affirms Tribunal’s Factual Findings - Grupo Antolin India Pvt Ltd (ITA 98 of 2024 - Bom HC)

    Department filed an appeal before the Bombay High Court and proposed the following substantial questions of law:

  • Whether the Tribunal was justified in deleting the Transfer Pricing adjustment for advisory services when the services paid for were different from those mentioned in the agreement and Transfer Pricing Study report.

  • Whether the Tribunal was justified when no documentary evidence for the services availed was produced by the Assessee.

  • Whether the Tribunal was justified when the Assessee’s allocation formula was arbitrary and did not meet the OECD Guidelines.

High Court’s decision

The Court dismissed the appeal on the ground that it raised no substantial question of law. Following observations were made by the Hon’ble Court:

  • The Court found no perversity in the Tribunal’s pure findings of fact that the Associated Enterprise (AE), Grupo Antolin Iriusa, S.A.E, did render advisory services to the Assessee for the relevant assessment year.

  • Contrary to the Department’s contention that the Tribunal only relied on emails, the record showed that:

    • The Assessee and AE had entered into an agreement which was produced.

    • There was evidence of the AE supplying such services to the group.

    • The AE has expertise in the Assessee’s line of business (manufacturing car interiors like headliners, door panels, and parcel trays).

    • The Tribunal, as the final fact-finding authority, found no considerable difference between the services rendered by the AE and those specified in the agreement, noting that all these are findings of fact.

  • The Court stated that it is not expected to re-appreciate the evidence under Section 260A of the Act. The findings were not based on no evidence, nor were they the result of ignoring or considering irrelevant evidence.