Markup on costs incurred is not an arm’s length remuneration for sourcing support service and the taxpayer should be compensated on the basis of value of the goods sourced through it

Li & Fung (India) Pvt. Ltd. Vs. DCIT (ITAT Delhi)- ITA No. 5156/Del/2010]

Tribunal ruling that the amount of compensation to be received ought to be a reflection of the functions performed, assets deployed and risks assumed by the associated enterprises (‘AE’) whilst discharging the business. On the concept of location savings the Tribunal held that the entire savings are passed on to customers, a part of it is retained by the AE, and the same should be factored in while determining the inter company transfer price.

Facts of the case

Li & Fung (Trading) Ltd., Hong Kong (“HK AE”) entered into contracts with its global third party customers for provision of sourcing services with respect to products²to be sourced by such global customers directly from third party vendors in India. For the sourcing services, the HK AE received a commission global customers at 5 percent of the FOB value of goods sourced. The taxpayer was engaged in providing sourcing support services to the HK AE, and was remunerated by the HK AE at cost plus 5 percent mark-up for provision of these services.

In order to determine the arm’s length price (“ALP”) of its international transactions, the taxpayer applied the Transactional Net Margin Method (“TNMM”) as the most appropriate method using Operating Profit/ Operating Cost (“OP/OC”) as the Profit Level Indicator (“PLI”) and compared an OP/OC of comparables at 4.07 percent as against its own OP/OC of 5.17 percent.

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