# AID15896: ABC Ltd. An Indian Company, acts as a limited risk distributor

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Q: ABC Ltd. An Indian Company, acts as a limited risk distributor in respect of the goods manufactured by its parent company.

Dr. Profit and loss account of ABC Ltd India for the year ended March 31, 2010 Cr.

 Particulars Amount(Rs.) Amount(Rs.) Particulars Amount (Rs.) Amount(Rs.) To Purchases 1,500 By Sales 2,500 To Gross profit 1,000 Total 2,500 Total 2,500 To Employee Cost 250 By Gross Profit 1,000 To Rent 200 To Legal Charges 100 To Depreciation 200 Total Operating Expenses 750 Total 1,000 Total 1,000 To Interest Cost 150 To Loss on sale of assets 20 To Net Profit before tax 80 Total 1,000 Total 1,000

In this case, ABC Ltd. purchases the goods from its AE only on receipt of orders received from third party domestic customer. Accordingly, it does not bear the risk of inventory.

In such a scenario, Berry Ratio would be an appropriate PLI as it represents a return on a company’s value added functions and assumes that those functions are captured in its operating expenses. Thus, a Berry Ratio > 1 implies that the distributor earns enough to be able to recover its operating costs.

ABC Ltd.’s Berry Ratio (Gross Profit/Operating Expenses) works out to be 1.33 (100/75).

Similarly, the mean of Berry Ratio of comparable companies is 1.17, which is illustrated as under:

 Name of the Company Gross Profit(Rs.) Operating Expenses (Rs.) Berry Ratio(GP/Op. Exp) Purchase price in comparable transactions at same quantity by domestic companies from their AEs A Ltd. 50 40 1.25 1,380 B Ltd. 75 80 0.94 1,390 C Ltd. 120 80 1.50 1,410 D Ltd. 90 90 1.00 1,370 Mean 1.17 1,387.5

Since, the Berry Ratio of ABC Ltd. is higher than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are at arm’s length.

Alternate Proposition I:

If Berry Ratio of ABC Ltd. Is 1.03 as compared to that of mean of comparable companies 1.17, is there any need to order for re-assessment of arm’s length price?

Since, the Berry Ratio of ABC Ltd. is lower than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are not at arm’s length.

Impact on assessment of Arm’s Length Price:

 Particulars Amount (Rs.) Net Profit as per Profit & Loss Account before tax 80 Add : Adjustment for over-statement in Purchase Price on goods purchased from AE [= Purchase cost debited in Profit & Loss A/c (-) Average Purchase Price of Comparable Companies= Rs.1,500 – 1,387.50] 112.50 Revised Net Profit after adjustment of over-statement in Purchase price but before tax 192.50

Alternate Proposition II:

Interest expense indicates only the extent to which the firm’s assets are secured by debt and the amount of depreciation recorded on a firm’s accounts is more likely to reflect the timing of that firm’s acquisition of assets than the actual depletion of capital assets. What would be the impact on assessment if these both are excluded from Operating expenses for calculation of Berry Ratio?

Impact on assessment of Arm’s Length Price:

 Particulars Amount (Rs.) Net Profit as per Profit & Loss Account before tax 80 Add : Interest expense already excluded in computing operating expense, hence not considered furtherAdd: Depreciation on assets added back Nil200 Revised Net Profit after adjustment of over-statement in Purchase price but before tax 380

Revised Operating Expenses = 750-200 =550

Revised Berry Ratio = (Gross Profit/Operating Expenses) works out to be 1.82 (1000/550).

Since, the Berry Ratio of ABC Limited. is higher than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are at arm’s length.