Over-the-top (OTT) platforms operating in India often enter into content cost-sharing arrangements with associated enterprises. These arrangements involve sharing the costs of producing or acquiring content, and the allocation of these costs must be at arm's length. The landmark Netflix India transfer pricing case provides significant guidance on the characterization of digital distribution models and the application of transfer pricing principles to content cost-sharing arrangements.
The Legal Framework
Section 161 establishes that any income arising from an international transaction shall be determined having regard to the arm's length price. Section 163 defines an "international transaction" as including a mutual agreement or arrangement between associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.
This provision specifically addresses cost contribution arrangements where associated enterprises agree to share costs for content production or acquisition. The cost or expense allocated or apportioned to, or contributed by, any such enterprise must be determined having regard to the arm's length price of such benefit, service or facility.
Types of Content Cost-Sharing Arrangements
Content Production Cost-Sharing
OTT platforms may share the costs of producing original content with group companies. The costs of production, including development, production, and post-production costs, are allocated among the participants based on expected benefits.
Content Acquisition Cost-Sharing
OTT platforms may share the costs of acquiring content licenses with group companies. The costs of licensing content from third parties are allocated among the participants based on expected benefits.
Content Development Cost-Sharing
OTT platforms may share the costs of developing content, including script development, concept development, and pilot production. These costs are allocated among the participants based on expected benefits.
Technology and Platform Cost-Sharing
OTT platforms may share the costs of developing and maintaining the streaming platform, including technology development, platform maintenance, and content delivery infrastructure.
The Netflix India Transfer Pricing Case
The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) delivered a landmark ruling in the case of Netflix Entertainment Services India LLP (AY 2021-22). The Tribunal set aside a ₹445-crore transfer pricing adjustment imposed on Netflix India.
Key Findings
The ITAT held that Netflix India neither receives nor is granted any licence or right to reproduce, distribute or exploit the content. The Tribunal rejected the re-characterisation of Netflix India as a full-fledged entrepreneur or content-provider. The Tribunal treated Netflix India as a limited-risk distributor (LRD).
Implications for Cost-Sharing Arrangements
The ruling has significant implications for content cost-sharing arrangements. Where the Indian entity is characterized as a limited-risk distributor performing routine functions, the cost-sharing arrangement should reflect the limited functions, assets, and risks of the Indian entity.
The Tribunal held that the transfer pricing adjustment founded on an assumed licence of intellectual property was without basis in fact or law. This emphasizes the importance of properly characterizing the Indian entity and ensuring that cost-sharing arrangements reflect the actual functions performed.
Transfer Pricing Methods for Cost-Sharing Arrangements
Comparable Uncontrolled Price Method
The CUP method compares the cost allocation in the controlled transaction with cost allocations in comparable uncontrolled transactions. This requires identifying comparable cost-sharing arrangements between independent parties.
Transactional Net Margin Method
The TNMM may be used where the participants perform relatively routine functions. The net profit margin of each participant is compared with comparable independent enterprises performing similar functions.
Profit Split Method
Where both parties contribute to the development and exploitation of content, the profit split method may be appropriate. The profits from the content are split between the parties based on their relative contributions.
Cost Plus Method
The cost plus method may be used where one party provides services to other participants. The costs are determined, and a mark-up is added to reflect the profit that an independent service provider would earn.
DEMPE Analysis for Content Intangibles
The DEMPE analysis is crucial for content cost-sharing arrangements. DEMPE stands for Development, Enhancement, Maintenance, Protection, and Exploitation of the intangible.
Development: Entities that develop content through production, acquisition, and creation should be appropriately compensated.
Enhancement: Entities that enhance content through localization, dubbing, subtitling, and marketing should receive returns.
Maintenance: Entities that maintain content through quality control, updates, and preservation should be compensated.
Protection: Entities that protect content through copyright registration, enforcement against infringement, and legal protection should be compensated.
Exploitation: Entities that exploit content through distribution, licensing, and commercialisation should be compensated.
Documentation Requirements
Rule 84 requires comprehensive documentation for content cost-sharing arrangements. This includes a description of the ownership structure, a profile of the multinational group, a broad description of the business, and details of the nature and terms of the cost-sharing arrangement.
A description of the functions performed, risks assumed and assets employed is essential. This functional analysis must identify who performs the DEMPE functions for the content intangibles. The documentation must include a record of the economic and market analyses, forecasts, budgets, and a record of uncontrolled transactions taken into account for analysing comparability.
Best Practices for OTT Platforms
OTT platforms should ensure that content cost-sharing arrangements are properly documented and reflect the actual functions performed, assets employed, and risks assumed. The characterization of the Indian entity should be based on a proper functional analysis.
The allocation of costs should be based on expected benefits and should be supported by appropriate documentation. The cost-sharing arrangement should be reviewed regularly to ensure it remains appropriate given changes in business operations, market conditions, and regulatory requirements.
Companies should consider obtaining advance pricing agreements for significant content cost-sharing arrangements. Regular benchmarking studies should be conducted to ensure that cost allocations are at arm's length. Documentation should be maintained contemporaneously with the transactions.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on transfer pricing for OTT platform content cost-sharing arrangements, please consult qualified legal and tax professionals.
Need Expert Legal Guidance?
Navigating the complex transfer pricing framework for OTT platform content cost-sharing arrangements requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive advisory services on transfer pricing documentation, benchmarking, advance pricing agreements, and dispute resolution. Contact us for expert guidance on your OTT platform transfer pricing matters.