Tribunal decision: Transfer pricing adjustment deleted for 'Payment of Royalty' transaction

The Tribunal partly allowed the appeal, directing the deletion of the transfer pricing adjustment related to the 'Payment of Royalty' international transaction. The matter concerning the 'Design Engineering Services' segment was remitted for the re-determination of the Arm's Length Price (ALP) by excluding a specific comparable entity.

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Issues Involved:
1. Transfer pricing adjustment for the international transaction of 'Payment of Royalty.'
2. Transfer pricing adjustment in the segment of 'Design Engineering Services.'

Detailed Analysis:

1. Transfer Pricing Adjustment for 'Payment of Royalty':

The first issue raised in the appeal concerns the transfer pricing adjustment of Rs. 12,98,02,765/- related to the international transaction of 'Payment of Royalty.' The assessee, a subsidiary of a German company, MAN, aggregated its 'Manufacturing activity' and 'Trading activity' for demonstrating them at Arm's Length Price (ALP). The Assessing Officer (AO) and Transfer Pricing Officer (TPO) segregated the 'Manufacturing segment' and focused on the Royalty payment of Rs. 25,93,47,186/- to the Associated Enterprise (AE) for technical know-how, determining the ALP separately under 'Other method' as per Rule 10AB. This resulted in a transfer pricing adjustment of Rs. 12,98,02,785/-.

The Tribunal observed that Section 92(1) of the Income-tax Act mandates that income from an international transaction should be computed having regard to the ALP. Section 92C(1) specifies that the ALP should be determined for each international transaction separately unless they are closely linked. The Tribunal emphasized that cross-subsidization of international transactions is impermissible, as it would contravene the intent of Chapter-X of the Act.

The Tribunal referred to the Punjab & Haryana High Court judgment in Knorr Bremse India (P) Ltd. Vs. ACIT, which held that several transactions could form a single composite transaction if they are closely linked. However, the onus is on the assessee to prove such linkage. In the present case, the Tribunal found no inextricable link between the payment of Royalty and other international transactions under the Manufacturing segment. Thus, the ALP of the Royalty transaction could not be aggregated with others.

Regarding the ALP determination, the TPO applied the 'Other method' and selected three comparables, resulting in an average profit rate of 4.56%. The assessee objected to the selection of comparables, arguing differences in the nature of business and territory of Royalty Agreements. The Tribunal noted that Rule 10AB allows considering the price for the same or similar uncontrolled transactions. The assessee provided evidence of the same uncontrolled transactions, showing that the AE charged higher Royalty rates to independent entities in Korea and China for the same product. Consequently, the Tribunal held that the Royalty transaction was at ALP and directed the deletion of the addition of Rs. 12.98 crore.

2. Transfer Pricing Adjustment in the Segment of 'Design Engineering Services':

The second issue pertains to the transfer pricing adjustment in the segment of 'Design Engineering Services.' The assessee rendered design engineering services to its AE, computing its Profit Level Indicator (PLI) at 12.12% under the TNMM, compared to the weighted average OP/OC of 5 comparables at 11.19%. The TPO altered the list of comparables, including Aabsys Information Technology Pvt. Ltd., resulting in a proposed transfer pricing adjustment of Rs. 1,48,05,266/-.

The assessee contested the inclusion of Aabsys Information Technology Pvt. Ltd., arguing that it was engaged in offering Geospatial and IT Services, not comparable to the assessee's Engineering Support Services. The Tribunal examined the functions performed by the assessee and noted that Aabsys Information Technology Pvt. Ltd. derived 78% of its revenue from Software services, whereas the assessee did not render any Software services. Additionally, no segmental information was available for Aabsys Information Technology Pvt. Ltd. to segregate its Engineering services revenue from Software services revenue.

Given these differences, the Tribunal held that Aabsys Information Technology Pvt. Ltd. could not be treated as comparable. The Tribunal ordered the exclusion of Aabsys Information Technology Pvt. Ltd. from the list of comparables and remitted the matter to the AO/TPO for re-determining the ALP of the international transaction of 'Design Engineering Services' by excluding Aabsys Information Technology Pvt. Ltd.

Conclusion:

The appeal was partly allowed. The Tribunal directed the deletion of the transfer pricing adjustment related to the 'Payment of Royalty' and remitted the matter concerning the 'Design Engineering Services' segment for re-determination of ALP.

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