I. Case Overview

Sony India Private Limited (“Sony India”) is a fully functional distributor of Sony electronic products from Japan, primarily selling these products in the Indian market. Sony India engages in various types of cross-border transactions with its affiliated entities, including purchasing and selling products, paying royalties, receiving IT and technical services, and providing consulting services.

The Indian tax authorities conducted a review and assessment of Sony India’s cross-border transactions with related parties and made tax adjustments on those transactions that did not comply with the arm’s length principle. Sony India disputed the conclusions drawn by the tax authorities as unreasonable and filed a lawsuit with the Delhi Income Tax Tribunal. The Tribunal supported Sony India’s claims and ordered the tax authorities to reassess the conclusions of their transfer pricing investigation in this case.

II. Key Points of Dispute

There are three main areas of dispute over whether the cross-border transactions involving royalties, consulting services, and accounts receivable complied with the arm’s length principle:

Royalties: The Indian tax authorities argued that the products associated with the royalties paid by Sony India were manufactured and sold to Sony India by a local company under a license from the parent company. Since Sony India did not directly use the parent company’s technology, it should not pay royalties to the parent company. Sony India contended that although some Sony products sold in India were produced by local third-party manufacturers, Sony India had already obtained the rights to produce and sell Sony products in the Indian market from the parent company and bore the associated risks.

Consulting Services: The Indian tax authorities claimed that some of the comparable companies selected by Sony India in its analysis of consulting services provided to related parties were flawed, leading to unreasonable pricing. Sony India argued that its transfer pricing policy was consistent with the arm’s length principle. Specifically, it applied the Transactional Net Margin Method (TNMM) for transfer pricing, using the full cost markup ratio as the profit level indicator, with the interquartile range for selected comparable companies’ full cost markup ratio being [9.44%, 13.72%].

Accounts Receivable: The Indian tax authorities argued that all accounts receivable exceeding 30 days resulting from transactions between Sony India and its affiliates should be treated as loans extended by Sony India to its related parties, with interest calculated at a comparable rate. Sony India argued that it had already considered the impact of accounts receivable and payable on the company’s profit level when establishing its overall transfer pricing policy and had made appropriate working capital adjustments in its benchmarking analysis. Therefore, accounts receivable should not be treated as loans. As a compromise, Sony India proposed using the London Interbank Offered Rate (Libor) as the comparable rate. However, the Indian tax authorities argued that since the sales transactions related to the accounts receivable occurred in India, the benchmark interest rate of Indian banks should be used as the comparable rate.

III. Final Ruling

Based on Sony India’s appeal to the Delhi Income Tax Tribunal, which included 63 grounds for appeal, the Tribunal’s final ruling is summarized as follows:

Royalties: Considering Sony India’s arguments and the supporting evidence provided, the Tribunal found that the relevant license from the parent company was granted to Sony India, while the local third-party manufacturers in India were merely subcontracted producers. Therefore, the Tribunal determined that the tax authority’s adjustments regarding royalties were not justified.

Consulting Services: The Tribunal stated that the tax authorities should provide the company with sufficient opportunities to provide further explanations.

Accounts Receivable: The Tribunal ruled that the net amount of accounts receivable after deducting accounts payable should be used as the base for calculating interest, with Libor as the comparable rate.

Based on these findings, the Tribunal ordered the tax authorities to reassess the transfer pricing adjustments in this case.

IV. Insights for International Businesses

（A）Strengthening Overseas Tax Risk Assessment and Response

Chinese companies expanding globally should thoroughly assess the tax laws and policy environment of the host country and establish a robust tax risk warning mechanism. They should also enhance compliance checks on related-party transactions to ensure adherence to local tax laws, thus avoiding legal disputes and financial losses.

（B）Improving Internal Transfer Pricing Management

Companies operating abroad should develop comprehensive internal transfer pricing management systems to ensure that pricing strategies are reasonable and compliant. They should also strengthen internal audits and monitoring and conduct regular transfer pricing risk assessments.

（C）Enhancing the Ability to Resolve International Tax Disputes

 When facing international tax disputes, companies should increase their awareness of legal rights and protections, familiarize themselves with international tax rules and the legal remedies available in the host country, and improve their capacity to effectively resolve tax disputes, thereby safeguarding their legitimate rights and interests.