Netflix Entertainment Services India LLP was incorporated in 2017 as the Indian group entity of Netflix. Under a distribution agreements, first with Netflix International B.V. and later directly with Netflix, Inc., the Indian entity was appointed as a non-exclusive distributor of access to the Netflix Service in India for FY 2021–22. Netflix India marketed subscriptions, entered into terms of use with Indian subscribers, invoiced and collected subscription fees, and remitted a distribution fee to its associated enterprise. The fee was computed as subscription revenue net of local costs, plus a fixed return, resulting in a return on sales of 1.36 percent. Netflix India did not receive any rights in content, technology, software, or trademarks, and did not perform content creation, platform development, or other DEMPE functions. All intellectual property and strategic decision making remained with the foreign associated enterprises.
The tax authorities rejected the characterisation of Netflix India as a limited risk distributor and treated it as an entrepreneurial provider of content and technology in India. They concluded that Netflix India effectively obtained licences to content and platform technology from its associated enterprises, and therefore should be regarded as paying royalty rather than a routine distribution fee. The tax authorities discarded the Transactional Net Margin Method applied by Netflix and invoked Rule 10AB to apply the ‘Other Method’. Relying on six third party royalty agreements, sourced from the RoyaltyStat database, they imputed a combined royalty rate of 57.12 percent of revenue for content and technology. This resulted in a transfer pricing adjustment of INR 4,449.34 crore. The Dispute Resolution Panel endorsed this approach and further supported it with an ad hoc attribution of group revenue to multiple functions allegedly performed in India, including content storage, infrastructure, marketing, customer management, and tech.
Netflix India challenged the recharacterisation and the method applied by the tax authorities. It argued that it was a routine distributor of access, operating on a cost plus basis, with no ownership or exploitation of intangibles, and no DEMPE functions. It contended that Open Connect Appliances installed with Internet Service Providers were merely cache devices used for bandwidth optimisation and did not constitute core technological assets. Netflix India maintained that TNMM was the most appropriate method, using operating profit over operating revenue as the profit level indicator, and benchmarked itself against software and related product distributors, due to the absence of direct OTT comparables. It argued that payments for access without transfer of copyright or other intellectual property do not constitute royalty.
Order
The Mumbai Income Tax Appellate Tribunal accepted Netflix India’s position in full on the transfer pricing issue. The Tribunal held that the contractual framework and actual conduct clearly established Netflix India as a limited risk distributor of access to the Netflix Service. It found that no licence or transfer of intellectual property had been granted, and that all DEMPE functions were performed outside India. The Tribunal held that Open Connect Appliances were logistical cache devices, and that their ownership did not imply entrepreneurial risk or technological ownership.
On method selection, the Tribunal held that TNMM was appropriate for a routine distributor, and that functional similarity, not industry classification, governs comparability. It rejected the application of Rule 10AB, holding that the ‘Other Method’ cannot be used where TNMM is workable and reliable. The RoyaltyStat agreements were found to be non comparable and to price an imaginary transaction that did not exist. The ad hoc revenue attribution by the Dispute Resolution Panel was held to have no basis under the transfer pricing rules. The Tribunal therefore deleted the entire transfer pricing adjustment of INR 4,449.34 crore, and accepted the arm’s length outcome under TNMM.