ITAT Delhi Mandates Re-examination of Royalty Benchmarking: Emphasis on Traditional Methods with Appropriate Comparables
Case Overview
The Income Tax Appellate Tribunal, Delhi Bench, delivered a significant ruling in the matter of Marks and Spencer (India) Private Limited Vs ACIT, addressing the critical issue of benchmarking consolidated royalty and service charges paid to associated enterprises. The Tribunal directed fresh analysis of arm's length pricing while emphasizing that traditional transactional methods should be preferred over profit-based approaches when suitable comparable data is accessible.
Background Facts
Marks and Spencer (India) Private Limited ("the assessee") commenced operations on 01.04.2005 as a wholly-owned subsidiary of Marks and Spencer Investments Pte. Ltd., Singapore. The company's primary business involves wholesale trading of branded apparel, accessories, leather goods, and toiletries. Additionally, the assessee provides sourcing support services to its group entities.
The assessee's operational framework involves procuring branded merchandise from independent manufacturers who produce goods specifically for the assessee. These products are subsequently sold to an affiliated joint venture operating in India. To enable manufacturing, procurement, branding, and trading activities, Marks and Spencer plc, United Kingdom ("M&S plc"), the ultimate parent company, granted the assessee various rights and provided comprehensive business support.
International Transaction Structure
Through a formal Services and Trademark License Agreement executed on 10.07.2014, M&S plc extended the following benefits to the assessee:
- Authorization to utilize the "Marks and Spencer" trademark
- Transfer of product specifications and technical know-how
- Access to design blueprints and patterns
- Information regarding approved suppliers
- Connectivity to the global business network
- Rights to distribute branded products to the Indian joint venture
Beyond intellectual property rights, the assessee received strategic support encompassing business development, marketing initiatives, buying and merchandising guidance, logistics coordination, IT infrastructure, supply chain optimization, human resources management, financial advisory, and legal assistance.
For this comprehensive bundle of rights and services, the assessee committed to paying a consolidated fee calculated at 6% of trading sales revenue.
During Assessment Year 2018-19, the assessee generated total trading revenue of Rs.298,97,68,941 and correspondingly remitted Rs.17,93,86,136 to M&S plc as consolidated charges. This payment was duly disclosed as an international transaction in Form 3CEB accompanying the income tax return.
Transfer Pricing Analysis by Assessee
The assessee benchmarked this international transaction using the Transactional Net Margin Method (TNMM), designating itself as the tested party and employing Operating Profit to Operating Revenue (OP/OR) as the Profit Level Indicator. The analysis revealed:
- Assessee's operating margin: 11.47%
- Comparable companies' margin range: 2.60% to 2.65%
Based on these results, the assessee concluded that the consolidated payment arrangement satisfied arm's length requirements under Indian transfer pricing regulations.
Transfer Pricing Officer's Intervention
During assessment proceedings, the Transfer Pricing Officer requisitioned comprehensive documentation regarding the international transaction. Despite receiving agreements, transfer pricing studies, functional analyses, and supporting evidence, the TPO rejected the assessee's approach.
The TPO's objections included:
- Rejection of TNMM as the most appropriate method
- Disregard for the economic analysis in the transfer pricing documentation
- Dismissal of corroborative Comparable Uncontrolled Price (CUP) analysis submitted by the assessee
- Independent application of CUP method without accepting supporting agreements
The TPO proceeded to select three comparable companies and determined an arm's length royalty rate of 3.92%. Consequently, a transfer pricing adjustment of Rs.6,21,87,194 was proposed on the payment of Rs.17,93,86,136.
Assessment and Appellate Proceedings
The Assessing Officer, operating through the National Faceless Assessment Centre, issued a draft assessment order under Section 143(3) read with Section 144C of the Income-tax Act, incorporating the TPO's proposed adjustment.
The assessee filed objections before the Dispute Resolution Panel, which upheld the transfer pricing adjustment and confirmed the TPO's findings. Following the DRP's directions, the final assessment order was passed, adding Rs.6,21,87,194 to the assessee's income.
Contentions Before ITAT
Assessee's Arguments
The assessee challenged the assessment order on multiple grounds:
Integration of Transactions: The bundled rights and services were intrinsically connected to trading operations, making segregation impractical for transfer pricing purposes.
Method Selection: TNMM represented the most appropriate method given the integrated nature of transactions. Entity-level benchmarking aggregating interrelated transactions was legally permissible and factually justified.