ITAT sets aside royalty ALP determination, directs TNMM application over Profit Split Method for transfer pricing

ITAT Bangalore set aside the determination of arm's length price (ALP) for royalty payments to associated enterprises, directing the Transfer Pricing Officer to apply Transactional Net Margin Method (TNMM) as the most appropriate method instead of Profit Split Method, following precedent from earlier assessment years. Regarding dividend distribution tax on non-resident shareholders, the tribunal remanded the matter to TPO/Assessing Officer for fresh consideration due to conflicting ITAT decisions and lack of finality on the issue. The appeal was partly allowed for statistical purposes.

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Issues Involved:
1. Determination of Arm's Length Price (ALP) for the international transaction of payment of royalty.
2. Rate of tax on dividend distributed to non-resident shareholders.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for the International Transaction of Payment of Royalty:
- The primary issue revolves around the determination of the Most Appropriate Method (MAM) for calculating the ALP for the payment of royalty to the Associated Enterprise (AE), Toyota Motor Corporation, Japan (TMC).
- The assessee, engaged in the manufacture of automotive components, paid Rs. 46,56,77,516 as royalty for using TMC's technology.
- The assessee adopted the Transactional Net Margin Method (TNMM) as the MAM in its Transfer Pricing (TP) study, which was rejected by the Transfer Pricing Officer (TPO) in favor of the Profit Split Method (PSM).
- The Dispute Resolution Panel (DRP) upheld the TPO’s decision, leading to the appeal before the Tribunal.
- The Tribunal noted that the issue of MAM had been previously settled in favor of the assessee for Assessment Years (AY) 2013-14 and 2014-15, where TNMM was deemed the most appropriate method.
- The Tribunal reiterated that the TPO and DRP had no basis to conclude that the technology's economic life was only five years or that the assessee was a start-up.
- The Tribunal emphasized that PSM is applicable only when both parties make unique and valuable contributions, which was not the case here as the assessee only leveraged TMC's technology without contributing unique intangibles.
- The Tribunal directed the TPO to apply TNMM as the MAM for AY 2016-17, consistent with the earlier years' decisions.

2. Rate of Tax on Dividend Distributed to Non-Resident Shareholders:
- The assessee contended that the Dividend Distribution Tax (DDT) on dividends paid to non-resident shareholders should be restricted to 10% as per Article 10 of the India-Japan Double Tax Avoidance Agreement (DTAA), instead of the 20.925% applied.
- The DRP held that DDT is a tax on the company, not on the shareholder, referencing the Bombay High Court’s decision in Godrej & Boyce Mfg. Co. Ltd Vs. Dy. CIT, which stated that DDT is a tax on the profits of the company.
- The DRP also cited similar positions upheld by the ITAT Mumbai in various cases and a South African High Court decision, asserting that DDT is outside the ambit of the tax treaty.
- The Tribunal noted that the ITAT Mumbai Bench had referred a similar issue to a Special Bench due to differing views, indicating that the matter had not attained finality.
- Consequently, the Tribunal remanded the issue to the TPO/AO for fresh consideration in accordance with the law.

Conclusion:
- The appeal was partly allowed, with the Tribunal directing the TPO to apply TNMM as the MAM for determining the ALP for the royalty payment and remanding the issue of the DDT rate on dividends to non-resident shareholders for fresh consideration.

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