TaxTMI 
TaxTMI 
2013 (7) TMI 35
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.... DRP has erred in law and on facts in concurring with findings of the Assessing Officer / TPO and disregarding the economic analysis undertaken by the appellant for establishing the arm's length price of the international transactions undertaken by the appellant without appropriate justification. Ground NO. 3 That the TPO/ Assessing Officer has erred in law and on facts in making an adjustment under section 92CA without returning a finding about existence of circumstance(s) specified in clauses (a) to (d) of sub-section (3) of Section 92C in case of the appellant. Ground No. 4 Ground No. 4.1 That the TPO/Assessing Officer has erred in law and on facts in holding that the ALP of royalty payment of Rs. 26,681,794/- paid by the appellant is 'nil' by resorting to various frivolous/ incorrect/ baseless statements and misplacing reliance on OECD guidelines which are not relevant to appellant's case so as to mislead the cause of justice, thereby clearly demonstrating a prejudiced mindset driven with the single minded intention to recommend a TP adjustment. Ground No. 4.2 That the Id. TPO/AO has erred in law and....
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.... it as an item of general' Plant and Machinery' for the purpose of allowing depreciation. Ground No. 6.2 Without prejudice to the above ground, the Id. AO has also erred in not regarding said UPS as 'Electrical equipment being Automatic Voltage Controllers', eligible for depreciation @80% under item III(8)(ix)(E)(c) of Part A of Appendix I to the Income tax Rules, J 962 ('the Rules'). Ground NO.7 That the Id. AO has erred in law and on facts in disallowing the loss of Rs. 18,894,690 incurred in connection with foreign exchange forward covers by treating the same as speculative in nature under section 43(5) of the Act. Ground NO.8 The appellant craves leave to add, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal. 3. Apropos the issue of Transfer Pricing Adjustment to royalty of Rs. 2,66,81,794/- M/s Samsung Electronics Company Limited (SEC Korea) is the ultimate parent company of Samsung Group and is a worldwide leader in semiconductor, telecommunication and digital convergence technology. M/s Samsung Telecommunication ....
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.... specifically cater to its technological needs. For the purpose or its manufacturing activity. the company procures proprietary/ critical raw materials, components etc. from group companies. The critical fixed assets etc required for manufacturing are also procured from overseas group entities. The assessee STI is responsible for the production of the hand sets on the assembly lines and also undertakes testing, quality assurance, etc. 4. It is also mentioned in Para 4.3.4 and 4.3.5 of the Transfer Pricing report that the Associated Enterprises own significant intangibles like designs, drawings, patents, know­how, technical information. testing quality control standards, etc. which are a result the R&D activities of the Group that are used by Samsung Telecommunications India. Further, Group companies also own the corporate brand name/logo. Samsung Telecommunications India is a licensed manufacturer that utilizes technical know-how etc. provided by associated enterprises. It does not undertake any significant R&D that leads to the development of non routine intangibles. 5. As staled above, you are paying royalty to your group companies for use of license technol....
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....ia and then part of it is exported to AEs. TPO opined that the royalty paid as a percentage of sales to the associated enterprise is not at arm's length because it amounts to collecting royalty on the sales to itself. He observed that all the AEs are typical within the umbrella of the multinational corporation. That even though it appears that the technical know-how is commercially exploited in India, in reality, the price for these activities are not fixed by the market force. TPO opined that whether the sales of the assessee are made within India to its AE or to the parent company does not make much difference to the principles of arm's length transactions. Assessing Officer referred to the guidelines of the OECD in respect of the exploitation of intangible are :- 6.14 "Arm's length pricing for intangible property must take into account for the purposes of comparability the perspective of both the transferor of the property and the transferee. From the perspective of the transferor, the arm's length principle would examine the pricing at which a comparable independent enterprise would be willing to transfer the property. From the perspective of the transf....
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.... benefit it has derived from the payments of royalty. No independent party would enter into the such kind of contract in which royalty is being paid to the AE to whom export or goods are being made. TPO observed that in fact this is transfer of profits out of India in the garb of royalty. 3.7 In the background of the above discussions, TPO held that the payment of royalty to the extent of Rs. 266,81,794/- in the international transaction is treated to be a payment against services having arms length value being NIL. 4. Assessee filed the objections against the order before the DRP. The DRP summed up the assessee's objections as under:- a. Once TNMM has been selected as the most appropriate method, questioning the appropriateness of the individual elements of operating cost is against fundamental TP principles. b. Royalty is not for use of 'Samsung' brand, name or logo but for use of technical know-how and expertise and that transaction of payment of royalty satisfies the principle of 'commercial expediency.' c. There is no difference in FAR profile of the assessee between sales made to overseas related parties versus unrelated pa....
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....CD. It is submitted that OECD has defined term "contract manufacturer" only in para 7.40 (quoted by us above). The definition purported by LdCIT(DR) is not envisaged under OECD}. The LdCIT(DR) may be directed to produce the source. Analysis of the definition quoted above clearly establishes that there must exist:- (i) Extensive instruction should exist as regards nature, quantity and quality, and (ii) An assurance should exist that the entire production will be purchased. None of the above are factually alleged or satisfied in the present case. If the above was met it ceases to be an independent manufacture and becomes rendering of a service to the person so instruction and purchasing. In Indian jurisprudence it means a works contract. In the present case, as stated supra, majority of sales are to non-AE's. Any mandamus on the modus of sale in specifically denied and not found to be untrue. Appellant is an independent manufacturer selling goods it manufacturer. Support may be drawn from:- (i) Central Board of Excise and Customs Circular No. F.No. 249/1/2006-CX.4 dated 27th October 2008 (copy filed during the course of hearing on 19th....
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....m export of goods are being made. In effect this is transfer of profits of India in the garb of royalty". In this regard it is submitted that in appellant's case export sales are not made to SEC Korea to whom royalty is being paid. Export sales are to other fellow subsidiaries (i.e Samsung Singapore, Samsung UAE and Samsung Philippines) and independent third party distributors. Reference: * pg 149 of PB-II * this fact was also clarified to the TPO vide submission dated 19th October 2010 @ para 43 onwards. Copy enclosed in PB-III pages 250 to 251@ Pg. 262, para 43. * this fact was also stated before DRP at page 68, Ground No. 3 (ii) In the relevant assessment year only small portion of appellant's total sales are to AE's (i.eaprox 33.40% in AY 07- 08 and 16.40% in AY 08-09). Bulk of the other sales (i.e 66.60% aprox in AY 07-08 and 83.60% in AY 08-09) are to non AE's. If this be so then appellant can't be termed as a contract manufacturer. {Reference SonaOkegawa Precision Forging ITA No. 4781/Del/2010 order dated 16th December 2011 copy enclosed pages 278 to 285 relevant @ page 284, 7th line from bottom}. (iii....
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.... balance export sales also royalty was being paid by the appellant @ 8% under the same royalty agreement to SEC Korea. Further the TPO (at page 127, last line) has held that the sales made in India or to AE's will not materially affect the arm's length principals of the transaction. While holding so he has ignored a crucial fact that in the instant case the basis of payment of royalty (i.enot lump sum but on a percentage of per unit basis of sale) is same whether the sales are domestic or export sales. For even export sales made to third independent parties royalty is being collected by SEC at the same rate. TPO @ pg. 129, para 7.4 has confused the issue by noting that the payment of royalty is "to itself" i.e., holding company. Further the TPO at page 127, para 7.2 has observed that "all the AE's typically within the broad umbrella of the multinational corporation". While doing so endeavoured to reach the so called economic substance ignoring the legal substance accepted and admitted in five separate jurisdictions. In such a situation the viel has only to be looked at and not looked through. ... Vodafone 341 ITR 1 SC @ pg. 36, para 68 of ITR citation ....
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....s deals with benefit derived by the assessee by making royalty payments. It is important to note that the TPO in his order has not doubted the benefits received by the assesse from payment of royalty. Infact, by accepting the arm's length nature of royalty paid on sales made to third parties, the TPO has also implicitly accepted the benefit derived by the appellant by making royalty payment (irrespective whether it is made to group companies or third parties). Therefore, the statement of TPO that the appellant has not been able to demonstrate the benefit and reliance placed on para 6.14 is baseless. Further, para 6.17 states that in some circumstances, the price of the intangibles may stand included in price of goods transacted with AEs and consequently, any additional royalty would have to be disallowed in the case of the buyer. It may be noted that in his order the TPO has not provided any specific reason for placing reliance on the above para. Further, the TPO has not demonstrated any facts or circumstances substantiating that the transfer price of goods include license charge/royalty and therefore, any additional payment for intangibles needs to be disallowed. If that was t....
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.... manufacture was not possible. (b) If Royalty was embedded in purchase price of raw material, it was equally embedded in those parts from which domestic and third party exports were made. How can the royalty be segregated. If not, the allegation is contradictory. (c) While considering deductibility of royalty under normal computational provisions it is rightly accepted that it is wholly and exclusively for the purpose of business. The allegation only is that it may be in capital field. In Perot's case (supra) a factual finding was recorded by Hon'be ITAT that "it is noted that this is not a case of ordinary business transaction"(refer para 10 of TTJ or SOT citation). 6.1 Ld. Departmental Representative submissions on the issue are as under:- "The TPO held that the assessee was akin to a contract manufacturer and is doing contract manufacturing for the group entities, as far as the assessee's related party exports are concerned. As per OECD definition, a contract manufacturer is CONTRACT MANUFACTURER: A manufacturer, in most cases, located in a low cost jurisdiction, which has to license to use an intangible property develo....
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....m the ruling of M/s Perot Systems TSI India Ltd. vs. DCIT (Delhi Trib.) dated 30.10.2009, on Hon'ble Sh. AD Jain and Shamim Yahya 5 ITR (Trib.) 106 Del. 130 TTJ 685, 2010 37 SOT 358. The assessee's argument of RBI approval for payment of royalty.:- RBI and the other Govt. Authorities are not Transfer Pricing Authorities. It has been held in the case of M/s Perot Systems TSI India Ltd. vs. DCIT (Delhi Trib.) that RBI's approval does not put a seal of approval on the true character of the transaction from the perspective of TP regulations as the substance of the transaction has to be judged as to whether the transaction is at arm's length or not. This view was upheld by the Hon'ble Punjab and Haryana High Court in the case of M/s Coca Cola India, 209 ITR 194 and by the Hon'ble Delhi High Court in the case of M/s Nestle India Ltd. 337 ITR 103, para 15 thereof. The assessee did not specify as to how were the prices fixed between its AEs and itself The assessee did not specify as to how were prices arrived at between itself and its related parties. The assessee has claimed that it purchased goods from its AE at Arm's Length....
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....e) dispatch to SEC at the Company's expenses such samples of regular production of the Company's Products as SEC may reasonably request to allow SEC to verify that production continues to be in accordance with the designs, specifications, manufacturing standards and usage factors prescribed and that it conforms to the standards and quality established by SEC." Ld. Departmental Representative has contended that an analysis of the above shows that effectively the assessee was doing contract manufacturing for its related parties, as it had obtained technology from the group entity and most of the raw materials were purchased from group entities and even the quantity and quality of raw and packaging materials, and machinery etc., and the suppliers were dictated by the Korean Parent (SEC). Ld. Departmental Representative further submitted that even the export sales were to the related parties, or to distributors specified by the group. In such a situation, the assessee's activities relating to export of manufactured items to group entities was akin to contract manufacturing. Ld. Departmental Representative opined that payment of royalty in such a situation would amount to....
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....ity. The production company bears low risks and may be assured that its entire output will be purchased, assuming quality requirements are met. In such a case the production company could be considered as performing a service, and the cost plus method could be appropriate, subject to the principles in Chapter II." 6.6 From the above definition, it is clear that there must exist:- (i) Extensive instruction should exist as regards nature, quantity and quality, and (ii) An assurance should exist that the entire production will be purchased. 6.7 In this regard, we note that SEC, Korea keeps a close watch on the quality of the raw-material and the production process. However, it does not determine the quantity of production and the terms of sales. There is no assurance to the assessee company that its entire production will be purchased. Ld. Counsel of the assessee has submitted the sale prices to the AEs are determined by market force and not dictated by the SEC Korea. It is noted that in the relevant assessment year only small portion of assessee's total sales are to AEs (i.e. approx 33.40% in AY 07-08 and 16.40% in AY 08-09). Bulk of the other sales (i.e 6....
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....the ld. Counsel of the assessee that that while doing so TPO endeavoured to reach the so called economic substance ignoring the legal substance accepted and admitted in separate jurisdictions. In such a situation the viel has only to be looked at and not looked through. 6.10 Furthermore, it has been contended by the ld. Counsel of the assessee that TPO in support of his views has relied upon para 6.14 and 6.17 of the OECD Commentary. That it will be relevant to note that para 6.14 of the OECD guidelines deals with benefits derived by the assessee by making the royalty payments. In this regard, ld. Counsel of the assessee has rightly pointed that the TPO in his order has not doubted the benefits received by the assessee from the payment of royalty. That in fact by accepting the arms length nature of royalty paid on sales made to third party, the TPO has implicitly accepted the benefit derived by the assessee by making royalty payment (irrespective whether it is made to group companies or third parties). Thus, we agree with the contention of the ld. Counsel of the assessee that in these circumstances, the statement of the TPO that assessee has not been able to demonstrate the bene....
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....m the AE as part of sale price. This being so, such fee paid became revenue neutral, that is to say, in case the assessee did not pay the fees on the sales made to the AE, a corresponding reduction in the price charged to the AE would have to be given by the assessee, lest the cost for the sale come down. Such latter methodology was not advisable, for it would create problems in the accounting. Also, the impact on the taxable profits would be nil. 17. It was on taking into consideration all of the above that the ld. CIT(A) deleted the addition wrongly made by the AO. We do not find any reason to record any variance with the well reasoned elaborate findings of fact recorded by the ld. CIT(A). The same are hereby upheld. The grievance sought to be raised by the Department is thus found to be without substance and shorn of merit. The same is hereby rejected." 6.13 We find that the facts of the above case are similar to the facts of this case as discussed hereinabove. Hence, the above decision also supports the case of the assessee. 7. In the background of the aforesaid discussions and precedents, we hold that royalty payment on exports sales by the assessee to the AE....
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....lishment of factory and operation of thereof. ii) Even after termination of agreement the assessee is entitled to continue manufacture. iii) The right to make or manufacture certain goods exclusively in India itself is an independent right secured by assessee from foreign company. 8.1 In the background of the above, Assessing Officer observed that it will be clear that assessee company gets :- i) Exclusive right to operate in the territory of India. ii) The complete know how in such details and in such manner that average qualified technicians are able to manufacture the products. iii) License to use trademark etc. for longer period of the giving it an enduring benefit. 8.2 Accordingly, Assessing Officer treated the payment of royalty as capital expenditure. Assessee objected about the above before the DRP. Assessee's main objections/contentions in this regard as noted by the DRP is as under:- "As per the agreement, the assessee did not have exclusive rights of operation, as wrongly noted by the Assessing Officer. The relevant extract of Clause 3.1 of the Agreement is reproduced below:- "SEC hereby grants to t....
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....(60) days notice, and on termination, the assessee is required to stop using the technical information and return the same to SEC. It is argued before us that the cases relied upon by the AO are distinguishable for the following reasons: a. A non-exclusive licence has been granted to the assessee to use technical information in order to produce cellular phones for sale in domestic and export market. b. That the payment is made in respect of an already established business and is not relating to setting-up of a factory. c. The technical information/know-how shall be returned to SEC on termination of the agreement. The tax payer has relied upon the following decisions: a. CIT Vs. Ciba of India Ltd. ('CIBA')(1968) (691TR 692) SC) b.CIT Vs. I.A.E.E. (Pumps) Ltd. (1997) 232 ITR 316 (SC). c. Alembic Chemicals Works Co. Ltd. Vs. ClT 177 ITR 377 (SC) d. Denso Haryana Private Limited Vs. CIT (ITA No. 381 of 2009) e. CIT Vs. G4S Securities Systems (India) Pvt. Ltd 2011-TIOL- 430-HC-DEL-IT f. CIT Vs. Sharda Motor Industrial Ltd. 22.7 CTR 606 (Delhi HC) g. DCIT Vs. VRV Breweries ....
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....ly noted following facts in his order: (i) That exclusive right is being given to appellant, and (ii) That the agreement is for use of trademark. A bare perusal of the agreement would show that both these facts are incorrect. This was specifically also pointed out before DRP @ page 31, last para of PB-1. DRP in its order has first recorded a fact @ page 32, para 6.3 that commercial production in mobile handsets commenced in February 2006 and the agreement was w.e.f. 26th February, 2006. However, at page 33, para 7 the DRP has erred in linking the supply of know-how with setting up of the business. Terms of the agreement clearly show that know-how was provided in the instant case to help in "continued production of mobile handsets" i.e. to help in manufacture of handsets. In fact from a perusal of chart at page 249 of PB-III would clearly show that royalty is being paid at sales minus cost of sales i.e the value addition taking place in the factory. Payment of royalty to SEC has nothing to do with setting up the business. If this be so them following cases support claim of appellant: * TEI Technology P. Ltd., 304 ITR 262 (Del) @ pg 263. C....
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....lhi High Court @ paras 15, 16, 18 and 19. Copy enclosed pages 371 to 390 of PB-III}. The AO has relied upon the case of Southern Switch Gear Ltd 232 ITR 359(SC) - It is submitted that this case is not applicable to the facts of instant case. Hon'ble Supreme Court in this case has upheld the judgment of Hon'ble Madras High Court reported in 148 ITR 272(Mad). Following distinguishing features/points are highlighted from the judgment of Hon'ble Madras High Court: (i) ITAT upheld disallowance of 25% of technical fees and 25% of royalty as capital expenditure (Pg 275 of ITR). Royalty paid was lumpsum. (ii) Appellant in this case was starting up the work or establishment of the factory and the technical assistance contemplated in the agreement covered the establishment of the factory and the operation thereof for the manufacture of transformers of all kinds and types. (Pg 275, last para and pg 280, 2ndpara of ITR). (iii) Exclusivity was provided thru a non-covenant clause in the agreement (pgs 277-78, para 5 of ITR) and a composite consideration was provided in the agreement for the provision of license information, goods and services rende....
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....nd the case of Jonas Woodhead (Supra). Assessing Officer observed that in this case the assessee company gets exclusive right to operate in the territory of India, the complete know how is in such details and in such manner that average qualified technicians are able to manufacture the products and the license to use trademark etc. for longer period gives an enduring benefit. 11. In this regard, assessee has submitted that as per the agreements the assessee did not have exclusive rights of operations, as wrongly noted by the Assessing Officer. As per the relevant clause 3.1 of the agreement, the SEC has granted the assessee a non-exclusive and non-transferrable licence to use the technical information in order to produce cellular phones for sale in domestic and export market. The payment is in the nature of running royalty and the rate is 5% and 8% of domestic and exports sales, respectively. Thus, it is clear that the agreement is not for use of trade mark, as wrongly noted by the Assessing Officer. But it is for grating it a license to use technical information for manufacture of products. Furthermore, the agreement can be terminated by either party in India by giving 60 days ....
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....tion / technology received by it from SEC. Furthermore, we note that in the assessee's submissions hereinabove, it has been clearly pointed out that the case of Sothern Switch Gear Ltd vs. C.I.T. (Supra) and Jonas Woodhead and Sons Ltd. (Supra) are not applicable on the facts of the case. 14. We further find that the case laws relied upon by the ld. Counsel of the assessee are germane and supports the case of the assessee. 14.1 In Munjal Showa Ltd. (Supra), it was held that expenditure incurred by the assessee on account of design and drawings fees and fees paid to foreign technicians for imparting training to Indian Technicians, related to the crafts of manufacturing and for a tenure and the documents, designs and specifications which have been supplied by the licensor are only for facilitating the said purpose of manufacturing and therefore, constituted the revenue expenditure. 14.2 In the case of Climate Systems India Ltd. (Supra), it was held by the Hon'ble High Court of Delhi that royalty paid by the assessee to the foreign collaborators had specified as percentage of its domestic export sales for using the technology and availing the technical services provid....
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....ions. DRP in its order bifurcated the amount of Rs. 4,14,02,228/- as under:- (a) Rs. 1,39,04,186/- being actual loss on account of difference in forex rates between the booking and payment on actual remittance during the year. It relates to fixed assets. The same has been added back by the assessee in computation of income, itself. . (b) Rs. 86,03,353/- being actual loss on account of difference forex rates between the date of booking and payment on actual remittance during the year. It relates to revenue. (c) Rs. 1,88,94,690/- being the actual expenses on part cancellation / surrender of unused forex contracts during the year. - As regards (a) the DRP held that the forex loss is added by the assessee itself. Hence, there is no question of adding it again and again. - As regards (b) the DRP held that there has been actual out flow of cash. Hence, it is allowable. - As regards (c) the DRP held that there has been actual outflow of cash but it relates to cancellation / surrender of unused forex contracts. These contracts have been settled by the difference. The DRP was of the opinion that these are speculative losses, in view of S....
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....also securities and units in its plain and neutral meaning. Consequently, trading in such items would fall within the scope of "speculative transactions" subject to other conditions being fulfilled." The derivatives referred in proviso (d) of section 43(5) are as referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956. As per which "derivative" includes:- (A) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; (B) a contract which derives its value from the prices, or index of prices, of underlying securities; Section 2(h) of Securities Control and Regulation Act defines "securities" to include derivative also. Therefore, derivative is also a commodity. Forward contracts are also derivatives. The dictionary meaning of "commodity" is "useful thing, article of trade". Therefore, currency, shares, securities and also units of UTI are also commodity. (Comfund Financial Services (I) Ltd. vs. DCIT 67 ITD 304 (Bang.) Hence, exchange loss of Rs. 1,88,94,690/- on part cancellation / surrender of unused fo....
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....e in the assessment year 1956-57. The ITO disallowed the claim on the ground that the loss was aspeculative loss and, in any event, as the assessee was following the mercantile system, it could not claim the loss in 1956-57. The AAC found that the transaction in which the loss arose was not speculative and this finding was upheld by the Tribunal. The AAC held that the loss did not relate to the relevant accounting year but the Tribunal held that the loss did not relate to the relevant accounting year but the Tribunal held that it was allowable in 1956-57 On a reference: Held, (i) that the assessee was not a dealer in foreign exchange. Foreign exchange contract were only incidental to the assessee's regular course of business. The AAC had made a categorical finding to this effect which had been upheld by the Tribunal. The loss was not a speculative loss but was incidental to the assessee's business and allowable as such. (ii) That though the claim related to the breach alleged to have occurred in 1952, the settlement of liability was done by agreement between the parties in the year of account relevant to the assessment year 1956-57. The amount of ....