TNMM Transfer Pricing: Use of ‘Other Method’ Only If Prescribed Methods Don’t Apply
What Is the “Other Method” in Transfer Pricing?
Indian transfer pricing rules recognize five primary methods for determining the arm’s length price: CUP, RPM, CPM, PSM, and TNMM plus a residual sixth option under Rule 10B(1)(f), read with Rule 10AB of the Income Tax Rules, 1962, commonly referred to as the “Other Method.” It allows the arm’s length price to be determined by reference to the price that would have been charged in a comparable uncontrolled transaction between independent parties under similar circumstances, without being tied to the specific mechanics of the five standard methods.
Critically, the other method is a fallback, not a first choice. It is available only where none of the five prescribed methods can be shown to be the most appropriate method for the transaction in question a taxpayer or tax authority cannot simply prefer it over TNMM or another standard method without first demonstrating why those methods don’t fit. Even where it is validly applied, Rule 10AB still requires reliable market data on comparable uncontrolled transactions to support the price adopted; it is not a license to use ad hoc or unverified benchmarks.
A recent Delhi High Court decision illustrates exactly how strictly this sequencing requirement is enforced.
Facts of the TNMM Transfer Pricing Case
In Principal Commissioner of Income Tax-7 v. SABIC India Pvt. Ltd. (ITA 514/2024 & CM APPL. 59663/2024, Delhi High Court, judgment dated 14 October 2024), the assessee, a part of the Sabic group, during the relevant previous year was engaged in the provision of marketing support services to the associated enterprise against a receipt of commission at a fixed rate.
Application of TNMM vs Other Method under Rule 10B
The said transaction was benchmarked applying Transactional Net Margin Method (‘TNMM’) as the most appropriate method, using Operating Profit / Value Added Expenses (‘OP/VAE’) as the Profit Level Indicator (‘PLI’) consistent with the methodology accepted by the Revenue for the assessee from AY 2009-10 through AY 2014-15.
The TPO, however, discarded TNMM and instead applied the Other Method under Rule 10B for the benchmarking analysis. The TPO held that the assessee was a commission agent and did not enter into contracts with the customers or acquire title to any inventory and held that the comparables selected by the assessee were engaged in trading operations and were therefore flawed.
For application of the Other Method, the TPO selected seven uncontrolled agreements and held that the median rate of commission charged under those agreements represented the arm’s length price for the marketing support services provided by the assessee. The TPO then applied that commission rate to the sales made by the associated enterprises in India to arrive at the arm’s length compensation for the assessee’s services. A transfer pricing adjustment was made accordingly.
Decision of the Dispute Resolution Panel
The DRP upheld the TPO’s decision to reject TNMM, holding that the TPO had furnished sufficient reasons justifying application of the Other Method.
Tribunal’s Ruling on TNMM Transfer Pricing
The Tribunal deleted the adjustment made by the TPO and upheld by the DRP on the following grounds:
- TNMM was accepted as the most appropriate method in earlier years and should not be changed unless there is a change in facts.
- Before adopting the “Other Method” under Rule 10B(1)(f), the TPO was required to give reasons for discarding the other five methods specified in Clauses (a) to (e) of Rule 10B(1).
The Tribunal relied on the earlier decisions in Sumitomo Corporation India Private Limited v. CIT, 387 ITR 611 (Delhi), and Li & Fung India Pvt. Ltd. v. CIT, 361 ITR 85 (Delhi), to support that TNMM with the Berry ratio as the Profit Level Indicator was the most appropriate method.
High Court TNMM Ruling and Key Observations
The Revenue challenged the order of the Tribunal before the Delhi High Court. The High Court highlighted that TNMM had consistently been accepted by the Revenue as the most appropriate method from assessment year 2009-10 to 2014-15.
The High Court, accordingly, upheld the order of the Tribunal, holding that:
- The TPO was not justified in rejecting TNMM unless there is a change in facts, especially where the method has been accepted by the Revenue in preceding years.
- The TPO was not justified in rejecting TNMM and applying the Other Method without providing justification or sound reasons.
Key Takeaways for Transfer Pricing India
The High Court undertook a detailed analysis of Rule 10AB and, on that basis, held that recourse to the Other Method is available only if none of the other five methods can be considered the most appropriate method.
To justify that the method applied is the most appropriate one, taxpayers should ensure their transfer pricing study provides reasons for rejecting all other methods, whether the outcome is TNMM or the Other Method.
Even where the Other Method genuinely is the most appropriate choice, it is necessary to place on record reliable market data on comparable uncontrolled transactions to support the price adopted.