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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
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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
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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.
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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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