2016 (11) TMI 123 - HC - Income Tax

High Court Upholds ITAT Decision on Royalty vs. Technical Assistance Fees 'sLength

The High Court upheld the Income Tax Appellate Tribunal's decision to treat royalty and technical assistance fee as separate transactions for ... Aggregation of international transactions - arm's length price - Transactional Net Margin Method (TNMM) - Comparable Uncontrolled Price (CUP) method - remand for fresh determination of ALPAggregation of international transactions - arm's length price - Whether royalty and technical assistance fee could be treated as a single composite transaction for benchmarking under TNMM or required segregation and separate examination - HELD THAT: - The Court held that aggregation of diverse international transactions into a single consolidated benchmarking exercise is not invariably permissible. The assessee had combined imports, payments of technical assistance fees, royalty, software payments and fixed asset purchases under a single 'Manufacturing' head and relied on projected aggregate margins and multi year comparable data. The Tribunal correctly observed that combined benchmarking is impermissible where the transactions are not so inter related as to make aggregate evaluation the most reliable means; actual, not projected, figures and year specific comparable data are ordinarily required. The Court found that the assessee failed to justify why the technical assistance fee could not be separately examined and that reliance on later profits did not discharge the initial burden to demonstrate arm's length nature of the technical fee. Consequently the conclusion that the technical assistance fee required independent scrutiny was upheld. [Paras 6, 7, 8, 15, 16]Answer against the assessee; segregation and separate examination of the technical assistance fee upheld.Transactional Net Margin Method (TNMM) - Comparable Uncontrolled Price (CUP) method - arm's length price - Whether the TPO, having accepted TNMM as most appropriate for the year's international transactions, could apply CUP method solely to the technical assistance fee - HELD THAT: - The Court held that once the TPO/AO has accepted a particular method as the most appropriate for determination of ALP for the year, it is not open to the TPO to pick and choose a different method for a single element of the transactions without justification. Each method embodies its own package of indicia and filters; permitting ad hoc application of multiple methods for parts of the same year's ALP determination would lead to inconsistency and uncertainty. Accordingly, the TPO could not validly apply the CUP method to the technical assistance fee after having accepted TNMM for the international transactions. [Paras 17]Answer in favour of the assessee; TNMM must be applied to the technical assistance fee as well.Remand for fresh determination of ALP - Comparable Uncontrolled Price (CUP) method - Transactional Net Margin Method (TNMM) - Whether the matter should be remitted to the AO/TPO for fresh determination of ALP and, if so, the scope of that exercise - HELD THAT: - The Court concluded that neither the assessee nor the TPO had applied a correct and complete methodology: the assessee's entity level TNMM use of projected figures and multi year comparables was unsatisfactory, while the TPO's CUP approach lacked requisite comparables and produced an untenable nil ALP. In view of these defects, the impugned order making the addition could not be sustained. The Court therefore set aside the order and remitted the matter for fresh determination by the AO/TPO, directing that appropriate method(s) be ascertained and applied, with the assessee to be given reasonable opportunity and to assist by providing comparable data. [Paras 4, 9, 10]Matter remitted to AO/TPO for fresh determination of ALP with opportunity to the assessee to furnish comparable data; earlier addition set aside.Final Conclusion: Appeal dismissed subject to the Court's findings: segregation of the technical assistance fee for separate ALP examination was justified (against the assessee), but the TPO could not apply CUP to that fee after accepting TNMM - TNMM must be applied to the technical fee; the order under challenge is set aside and the matter remitted to the AO/TPO for fresh determination of ALP in accordance with these directions. Issues Involved:1. Segregation of royalty and technical assistance fee as separate transactions for benchmarking and computing arm's length price (ALP).2. Applicability of the Transactional Net Margin Method (TNMM) versus the Comparable Uncontrolled Price (CUP) method for benchmarking technical assistance fee.Detailed Analysis:Issue 1: Segregation of Royalty and Technical Assistance FeeThe High Court examined whether the Income Tax Appellate Tribunal (ITAT) was correct in treating royalty and technical assistance fee as separate transactions for benchmarking and computing ALP. The assessee, a Joint Venture Company, had categorized multiple international transactions under one broad head for benchmarking using the TNMM. The Transfer Pricing Officer (TPO) rejected this entity-level approach, arguing that each transaction should be benchmarked separately. The ITAT upheld this view, stating that combined benchmarking of all international transactions is not in accordance with law. The ITAT also noted that the assessee used projected operating profit margins rather than actual figures, which is incorrect under Rule 10B(4). The High Court concurred, emphasizing that the initial burden is on the assessee to prove that international transactions are at arm's length. The court held that the explanation for the payment of technical assistance fees was correctly not accepted, and the remit directed by the ITAT was upheld.Issue 2: Applicability of TNMM versus CUP MethodThe second issue was whether the ITAT was right in rejecting the TNMM for benchmarking the technical assistance fee and instead applying the CUP method. The TPO had accepted TNMM for other international transactions but applied the CUP method for the technical assistance fee, determining its ALP as nil. The ITAT found this approach flawed, stating that when technical information was admittedly obtained, it could not be said that the assessee should not have paid any consideration. The High Court agreed with the ITAT, noting that the TPO should have sought comparable uncontrolled transactions for a proper CUP method application. The court emphasized that once a method is accepted as the most appropriate, it should be applied consistently across all transactions. The High Court concluded that the TPO's selective application of the CUP method for the technical assistance fee was incorrect. The second question was answered in favor of the assessee, affirming that TNMM should have been applied for the technical fee payment as well.Conclusion:The High Court dismissed the appeal, upholding the ITAT's decision to remand the case for fresh determination of ALP by the TPO/AO while applying the TNMM consistently across all transactions, including the technical assistance fee.