Cipla Kenya Limited, a distributor of pharmaceutical products from its Indian parent company (Cipla India), had applied the Transactional Net Margin Method (TNMM) and used a benchmarking study identifying 21 comparables with an interquartile range operating margin from 1.60% to 9.14%. It had earned a margin of 3.02%, which was within this range.
However, the Kenya Revenue Authority (KRA) rejected this margin, adjusting it to the median point of 5.08%, arguing that the comparables selected had significant defects (such as different product types, markets, and regulatory environments). The KRA invoked Paragraphs 3.57 and 3.62 of the OECD TP Guidelines, suggesting that due to these defects, the median provided the most reliable arm’s-length result.
Cipla Kenya appealed, arguing that the median is applicable only when comparability defects cannot be identified or quantified. Cipla argued that since the KRA explicitly identified the defects (e.g., differences in products, marketing, and regulatory regimes), the KRA should have quantified adjustments rather than applying the median. Cipla further argued that Kenyan law and TP rules do not mandate using the median if another point within the interquartile range is justified.
In the assessment the KRA had also disallowed various employment costs claiming Cipla failed to provide sufficient documentation. Cipla maintained that comprehensive documentation and reconciliation of costs had been provided, but KRA had disregarded this evidence.
Decision
The Tribunal allowed Cipla’s appeal and set aside KRA’s tax assessments.
The Tribunal held that the KRA was not justified in adjusting Cipla’s operating margin to the median. It clarified that according to OECD Guidelines and Kenyan TP practice, the median may only be used if comparability defects are unknown or unquantifiable. Since the KRA explicitly identified defects, applying the median was inappropriate, and Cipla’s selected operating margin (3.02%), being within the interquartile range, was valid.
The Tribunal found that since the TNMM already accounted for profitability on turnover, disallowing expenses used to calculate taxable profit would result in double taxation. Consequently, it held the KRA had erred in separately disallowing employment-related expenses.