Shared service charge cost-sharing and trademark royalty rates in manufacturing TNMM analysis: aggregation rejected; 4.5% royalty ALP remanded

The dominant issue was whether payment of shared service charges could be aggregated with manufacturing-related international transactions under TNMM. The Tribunal held aggregation impermissible because the services were not shown to be closely linked to manufacturing and, in any event, the taxpayer failed to prove actual receipt of services or substantiate the cost-sharing arrangement; the TP disallowance was therefore upheld and the additional ground dismissed. On trademark/royalty payments, the Tribunal held the TPO erred in disallowing the incremental 0.5% by treating it as unnecessary; the ALP had to be determined for the combined royalty transaction at 4.5%. The matter was set aside and remanded to the AO/TPO for fresh ALP determination.

---

---

Issues Involved:
1. Transfer pricing addition for 'Allocation of shared service charges'.
2. Transfer pricing addition for 'Payment of Trademark charges'.
3. Adoption of 'Combined Transaction approach under the Transactional Net Marginal Method (TNMM)' for benchmarking international transactions.

Issue-wise Detailed Analysis:

1. Transfer Pricing Addition for 'Allocation of Shared Service Charges':

The first issue pertains to the confirmation of a transfer pricing addition of Rs. 2,13,97,960/- for the international transaction of 'Allocation of shared service charges' for the assessment year 2011-12. The assessee, part of the Knorr Bremse group, did not benchmark this transaction, claiming it was a 'Cost allocation arrangement'. The Transfer Pricing Officer (TPO) found no evidence of the actual receipt of services or any cost allocation working. The TPO determined Nil Arm’s Length Price (ALP) due to the lack of evidence, a finding affirmed by the Commissioner of Income Tax (Appeals) [CIT(A)]. The Tribunal upheld this decision, noting the absence of any primary documentation or evidence of services rendered by the Associated Enterprise (AE).

The assessee's additional ground to adopt the 'Combined Transaction approach under the TNMM' was admitted as a pure question of law. However, the Tribunal rejected this approach, stating that the transactions of shared service charges and manufacturing activities were not 'closely linked transactions' and thus could not be aggregated. The Tribunal emphasized that the term 'transaction' includes plural transactions only if they are closely linked, which was not the case here. Consequently, the additional ground was dismissed, and the disallowance was upheld due to the failure to prove the receipt of services.

2. Transfer Pricing Addition for 'Payment of Trademark Charges':

The second issue involves the confirmation of an addition of Rs. 19,96,178/- for the international transaction of 'Payment of Trademark charges' for the assessment year 2011-12. The assessee had an agreement with KB-SfN effective from 01-01-2011 to pay 0.5% on third-party gross sales for the use of trademarks. The TPO noted that the earlier 'Technical Transfer Agreement' (TTA) already included consideration for the use of trademarks, and thus, the additional payment was unwarranted. The Tribunal found that the assessee was already paying 4% royalty under the TTA, which included the use of trademarks. The Tribunal held that the payment of 0.5% under the new agreement should be considered as an increase in the royalty rate to 4.5%. The matter was remitted to the AO/TPO to determine the ALP afresh, considering the total payment of royalty at 4.5%.

For the assessment years 2012-13 and 2013-14, similar issues were raised regarding the payment of 0.5% for the use of trademarks. The Tribunal set aside the impugned orders and remitted the matters to the AO/TPO for fresh determination of the ALP, following the same directions as for the assessment year 2011-12.

3. Adoption of 'Combined Transaction Approach under the TNMM':

The assessee raised an additional ground to adopt the 'Combined Transaction approach under the TNMM' for benchmarking the international transaction of payment of shared service charges. The Tribunal admitted this ground as it involved a pure question of law. However, on merits, the Tribunal rejected this approach, stating that the transactions of shared service charges and manufacturing activities were not 'closely linked transactions' and thus could not be aggregated. The Tribunal emphasized that closely linked transactions must be similar or alike, which was not the case here. The additional ground was dismissed, and the aggregation approach was rejected.

For the assessment year 2013-14, the Tribunal upheld the addition of Rs. 26,22,597/- for payment of shared service charges, as the assessee failed to produce evidence of receipt of services or cost allocation without markup. The Tribunal also rejected the combined transaction approach for this year, following the reasoning given for the assessment year 2011-12.

Conclusion:

The Tribunal upheld the disallowance of shared service charges due to the lack of evidence for the receipt of services and rejected the combined transaction approach for benchmarking. The matter of trademark charges was remitted to the AO/TPO for fresh determination of the ALP, considering the total royalty payment at 4.5%. The appeals were partly allowed for statistical purposes.

---