The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has deleted a transfer pricing adjustment of approximately ₹8.29 crore made in respect of licence fees paid for the distribution of Hollywood films and television content.
The Tribunal held that the transfer pricing authorities could not reject the Transactional Net Margin Method (TNMM) merely because the comparable companies selected by the assessee were engaged in software or hardware distribution rather than the distribution of films and television programmes.
Buy Now: Think Before You Pay Cash: 50+ Landmark Rulings on Section 40A(3) Of The Income Tax Act, 1961
The Bench of Beena Pillai (Judicial Member) and Jagadish (Accountant Member) observed that differences in the products distributed do not automatically render a company unsuitable for comparison under TNMM. The appropriate inquiry must focus on the functions performed, assets employed, risks assumed and the reliability of the available financial information.
The appellant/assessee filed its income-tax return declaring a total income of approximately ₹13.51 crore. Its case was selected for scrutiny, following which the international transaction involving the payment of licence fees for its television syndication business was referred to the Transfer Pricing Officer.
The Transfer Pricing Officer rejected the benchmarking analysis conducted by the company under TNMM. The officer instead adopted a revenue-split mechanism under the “Other Method” and proposed a transfer pricing adjustment of approximately ₹8.29 crore.
After incorporating the adjustment, the Assessing Officer assessed the company’s total income at approximately ₹21.80 crore.
The Dispute Resolution Panel upheld the Transfer Pricing Officer’s approach, prompting the company to approach the ITAT.
Under the relevant inter-company arrangement, the company’s associated enterprise granted it the right to distribute licensed Hollywood films, English television shows and other content to broadcasters and over-the-top platforms in specified territories.
The territories included India, Nepal, Bhutan, Bangladesh, Pakistan, Sri Lanka and the Maldives.
The associated enterprise was responsible for developing or acquiring the content, financing its acquisition and maintaining and protecting the underlying intellectual property rights. The Indian company distributed the licensed content to broadcasters and OTT platforms on an “as is” basis.
The arrangement provided the Indian company with an assured distribution margin of 2% of revenue after recovering its operating expenses.
The consideration payable to the associated enterprise was calculated after deducting distribution expenses, other operating expenses and the distribution fee from the gross revenue generated through the exploitation of the licensed content.
If the distribution fee and expenses exceeded the gross revenue, the Indian company was entitled to recover the shortfall from the associated enterprise through a subvention payment. According to the company, this arrangement established that it operated as a limited-risk distributor.
For benchmarking the international transaction, Sony Pictures adopted TNMM as the most appropriate method and used the ratio of operating profit to operating revenue as its profit-level indicator.
Since reliable independent companies engaged in the distribution of comparable film and television content were unavailable, the company conducted a lateral search for businesses performing comparable distribution functions.
This exercise resulted in the selection of 14 companies primarily engaged in distributing software and hardware products.
The company argued that TNMM requires broad functional similarity and does not mandate complete product similarity. It maintained that software distribution companies were suitable comparables because their underlying distribution functions were broadly similar.
The Transfer Pricing Officer rejected the software and hardware distributors on the ground that their activities could not be compared with the distribution of media content.
The officer initially considered adopting the Comparable Uncontrolled Price Method by referring to third-party royalty agreements. The transaction was ultimately benchmarked through a revenue-split mechanism under the “Other Method”.
The officer assigned weightages of 15% to functions, 75% to assets and 10% to risks. Based on those weightages, 10% of the relevant revenue was allocated to the Indian company and 90% to its associated enterprise.
The Transfer Pricing Officer found the Indian company’s existing share of revenue inadequate and consequently proposed an adjustment of approximately ₹8.29 crore.
Before the Tribunal, the company contended that the weightages assigned by the Transfer Pricing Officer had no scientific, legal or economic basis.
It argued that the associated enterprise owned or acquired the content, financed its acquisition and assumed the economically significant risks connected with the intellectual property. The Indian entity neither owned nor developed the underlying content and was assured of a return on its distribution activity.
The company further submitted that the selected software distributors had already been examined by the Transfer Pricing Officer. They were not rejected because of any specific defect in their operating margins or functional profiles but solely because they did not operate in the film and entertainment industry.
The Revenue, however, contended that distributing media content involved functions and risks materially different from the distribution of software. It pointed to functions such as pricing, statutory approvals, logistics, invoicing, collection and dealing with the risk of unauthorised exploitation of content.
Examining the contractual arrangement, the Tribunal observed that the company did not own, develop or acquire the underlying content. It was also not responsible for the expenditure incurred in acquiring the content or protecting the associated intellectual property.
The remuneration arrangement was structured to provide Sony Pictures with an assured return from its distribution activity. These features, according to the Tribunal, supported the company’s characterisation as a limited-risk distributor.
However, the Tribunal clarified that the precise functions performed and risks assumed by the parties must always be examined in light of their contractual terms and actual conduct.
The ITAT ruled that the suitability of a comparable under TNMM cannot be determined solely by looking at the nature of the product distributed.
The relevant question is whether the enterprises perform broadly comparable functions, employ similar assets, assume similar risks and whether their financial information permits a reasonably reliable comparison of net operating margins.
Although product differences may affect comparability in appropriate cases, they do not automatically make a comparable company unsuitable when the underlying distribution functions and economic characteristics are sufficiently similar.
The Tribunal consequently found that the mere fact that the selected companies distributed software or hardware did not provide a sufficient basis for rejecting the company’s benchmarking exercise.
The authorities were required to examine the functions, assets, risks, contractual arrangements and financial data in accordance with the statutory comparability requirements.
The Tribunal also rejected the Revenue Split Method adopted by the Transfer Pricing Officer.
It observed that the record did not disclose any comparable uncontrolled transaction or reliable market evidence from which the 15:75:10 weightages assigned to functions, assets and risks could be objectively derived.
While identifying the functions and risks of the parties was relevant, the Tribunal distinguished that exercise from determining the economic value attributable to each function or risk.
The Transfer Pricing Officer had failed to demonstrate through cogent material how the specified weightages had been determined or how they represented the remuneration that independent enterprises would have agreed upon.
According to the ITAT, merely assigning percentages to functions, assets and risks, without a reliable basis for quantifying their respective economic contributions, could not establish the arm’s length price of the licence fees.
The statutory determination of an arm’s length price cannot be founded upon an allocation unsupported by an objective economic basis, the Tribunal said.
Sony Pictures had also submitted an alternative revenue-split calculation before the Dispute Resolution Panel on a without-prejudice basis.
The Revenue sought to rely upon this alternative working to support the use of the Revenue Split Method.
The Tribunal rejected that contention, observing that the company’s primary case throughout the proceedings was that TNMM was the most appropriate method and that the Revenue Split Method adopted by the officer lacked a legal and economic foundation.
Therefore, the alternative calculation could not be treated as an admission that the Revenue Split Method had been validly applied.
The ITAT concluded that the Revenue had neither shown that the selected companies were wholly unsuitable because of specific and material differences in their functions or risks nor demonstrated that their net margins could not reliably benchmark the company’s distribution activity.
In contrast, the revenue-split exercise adopted by the Transfer Pricing Officer was based on weightages for which no adequate objective foundation had been established.
The Tribunal therefore held that the rejection of Sony Pictures’ TNMM analysis and the determination of the arm’s length price through an ad hoc Revenue Split Method could not be sustained.
It deleted the transfer pricing adjustment of approximately ₹8.29 crore and directed the Assessing Officer to determine the arm’s length price of the licence-fee transaction by adopting TNMM as the most appropriate method.
The Assessing Officer was directed to consider the software-distribution comparables selected by the company, which had already been examined by the Transfer Pricing Officer, and recompute the company’s total income in accordance with law.
Since the dispute was decided in favour of the company on merits, the Tribunal declined to adjudicate its additional limitation grounds and dismissed them as infructuous.
Membership Required to Access Case Details & Order Copy
To view the complete Case Details and Download Order Copy, you must have an active membership. Please subscribe to continue.
