TaxTMI 
TaxTMI 
TaxTMI 
2014 (5) TMI 734
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....A.Y. 2005-2006 (Assessee's Appeal): 2. The assessee is a company which derives income from manufacture and supply of Air and Gas separation equipment and from providing related services. For the Asst. Year 2005-06 It has filed the return of income on 29.10.2005 showing Income of Rs.8,51,61,564/-. During the assessment proceedings, the AO noticed that during the F.Y 2004-05 the assessee has entered into international transactions with its Associated Enterprise (AE). For computation of the arm's length price (ALP) of such transactions, the AO has made reference to the Transfer Pricing Officer (TPO) u/s.92CA(l) of the Act. In response to this, after making necessary verification in the matter, the TPO noted that various international transactions made by the assessee with the AE, as reported in the audit report in Form No.3CB are at arm's length, except the International transactions pertaining to royalty paid to the AE, which was not reflected In the said Form No.3CB report. 2.1 The TPO noted that the assessee company which was incorporated In 1992, is engaged in undertaking design, manufacturing, marketing and sale of air and gas separation equipments/plants. He furthe....
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....ns. 2.2 Later, in conformity with such order passed by the TPO, the AO made addition of Rs.l,42,84,061/- to the Income of the assessee, towards adjustment in the ALP of such transaction u/s.92CA(3) of the Act and completed the assessment determining total income at Rs.9,94,45,625/-, vide order dated 28.11.2008 passed u/s.143(3) of the Act. 3. The assessee has filed appeal before CIT(A) contesting said addition made in the assessment. 3.1 During the hearing of appeal before CIT(A) in the written submissions filed by the Id. Authorized Representative, it was submitted that during the relevant year the assessee company manufactured and sold certain goods to independent third parties and its associated enterprise. Objecting to such disallowance made by the TPO, after observing that permanent establishment in India of a non-resident company cannot pay any royalty to the parent company, it was submitted that, it is nowhere specified in the Act that royalty payment by branch office to the parent company is to be disallowed. It was further submitted that during subject assessment year' the royalty paid by the assessee is with respect to sales to independent third parties. It was sta....
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....ade by the TPO that such sales were made to the AE during the previous year. Even though the assessee contends that the company In their case and the said AE are independent entitles. It has not been stated that no sale has been made to the AE. In absence of details of the sales made during the previous year, furnished by the assessee, I am inclined to believe that the assessee has made sales to the AE during the previous year. Further, from the assessment record for this assessment year in case of the assessee, made available to me, it appears that the assessee has not furnished such details i.e., the details with respect to sales made during the previous year, during the assessment proceedings. Under such circumstances, even though the assessee has contended that it has made sales only to Independent third parties, such claim is not verifiable. However, it may be mentioned when the assessee has earlier stated that the company in their case and the AE are to be treated as independent entities, so far as the sales are concerned, it shows the assessee admits that some sales were made by them to the AE during the previous year under consideration. Further, from the statement of royal....
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....n the assessee and its associated enterprise were not at an arm's length price. 1.2 That on the facts and circumstances of the case and in law, the Transfer Pricing Officer ("TPO")/ Assessing Officer ("AO") / CIT(A) has erred in law and on facts, in making several observations and findings which are based on incorrect interpretation of law and without appreciating and understanding the intricacies of the facts of the case. 1.3 The learned TPO I AO has erred in law and on, in determining the arm's length price for an international transaction wherein no specific reference has been received by the AO, and thus the order of the AO I TPO is bad in law and should be set aside. 1.4 That on the facts and circumstances of the case and in law, the CIT(A) has erred in law and on facts, in holding the arm's length price in respect of royalty paid by Appellant to its associated enterprise to the extent of Rs 71,42,031 to be nil. 1.5 That on the facts and circumstances of the case and in law, the TPO / AO / CIT(A) has erred in observing that no royalty can be paid by an entity with respect to sales made to its associated enterprises where the entity avails technical knowhow from....
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....ils of sales ma to non AEs and AEs which was in the possession of the assessee, the learned CIT(A) erred in assuming that 50% of sales were made to Non-AEs. 3. On identical facts and circumstances, for the detailed reasons recorded in the report of the TPO for the A. Y.2006-07 (which is also under appeal before the Hon'ble IT AT), the order of A.O./TPO may be upheld. 4. The learned CIT(A) ought to have noticed that the original agreement for transfer of know-how entered on 26-05-1992 was valid for ten years and as the assessee-company has absorbed the know how before the F. Yr.1999-2000, there was no need to pay any royalty in the year under consideration 5. The CIT(A) ought to have upheld the order of the TPO determining ALP as 'Nil' given the fact that the assessee admitted that there was reverse flow of technology and hence there can be no usage of technical know-how of the Associated Enterprise. 6. The CIT(A) ought to have noticed tha....
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....ere is not a patented one. (c) From last so many years, the taxpayer is in a position to transfer technology to its AEs as is evident from deployment of its own engineers to execute the projects at different locations outside the country. The services rendered by the engineers of the taxpayer encompassed all the areas of engineering that goes into manufacturing of ASUs. Engineers deputed on onsite at these locations were stationed for months together, which mean all the core functions in execution and commissioning of ASUs were actually performed by the Engineers of the taxpayer. In fact there is a reverse flow of technology from the taxpayer to its AEs and not vice versa. (d) The taxpayer rendered engineering services to its AEs at a meager price which can be seen from the information furnished by the taxpayer. Further, major portion of the foreign travel expenses are borne by the taxpayer. AEs of the taxpayer in a way exploited the services of the taxpayer in their advantage by compensating the services received either at cost or below cost. The prices charged by AEs when they execute projects outside India vis-à-vis prices charged per man day if ....
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.... case had been suffering losses; the Delhi High Court, while holding that so long as the expenditure or payment by assessee has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning, observed as follows: "16. The Organization for Economic Co-operation and Development ("OECD", for short) has laid down "transfer pricing guidelines" for Multi-National Enterprises and Tax Administrations. These guidelines give an introduction to the arm's length price principle and explains article 9 of the OECD Model Tax Convention. This article provides that when conditions are made or imposed between two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises then any profit which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, if not so accrued, may be included in the profits of that enterprise and taxed accordingly. By seeking to adjust the profits in the above manner....
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....cription of capital. The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price. An example of this circumstance would be a sale under a long-term contract, for a lump sum payment, of unlimited entitlement to the intellectual property rights arising as a result of future research for the term of the contract (as previously indicated in paragraph 1.10) While in this case it may be proper to respect the transaction as a transfer of commercial property, it would nevertheless be appropriate for a tax administration to conform the terms of that transfer in their entirety (and not simply by reference to pricing) to those that might reasonably have been expected had the transfer of property been the subject of a transaction involving independent enterprises. Thus, in the case described above it might be appropriate for the tax administration....
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.... jurisprudence of our country earlier. It has been held by our courts that it is not for the revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur. We may refer to a few of these authorities to elucidate the point. In Eastern Investment Ltd. v. CIT, (1951) 20 ITR 1, it was held by the Supreme Court that "there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of the Income Tax Act". It was further held in this case that "it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned". In CIT v. Walchand & Co. etc., (1967) 65 ITR 381, it was held by the Supreme Court that in applying the test of commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. It was furthe....
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.... business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above. 22. Even Rule 10B(1)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was un-remunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allow ability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. T....
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....pra)" 13. We also draw support from the Ahmedabad Bench of Tribunal in the case of KHS Machinery (P) Ltd. v. ITO [2012] 53 SOT 100 (URO, wherein the Hon'ble Tribunal on the issue of disallowance made by the TPO of payment of royalty, has held as under: "The assessee had not made the one-time payment but making the continuous payment to the know-how provider which has been accepted by the Department in the past. The assessee has been charging 5 per cent royalty on each and every transaction and therefore the said payment cannot be said to have been paid on the aggregate amount, as argued by learned CIT-Departmental Representative. The findings of the AO in considering the royalty charges as nil as ALP cannot be accepted since the AO in the present case has not brought on record, the ordinary profits which can be earned in such type of business. Therefore in our view the payment of royalty is not hit by the provisions of s. 92 of the Act and there is no reason to hold that the expenses should not be allowed under s. 37(1) of the Act, since the expenditure has been incurred by the assessee during the course of bu....
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....e business and commercial expediency of the assessee which is erroneous as per the provisions of the Act as laid down clearly by the Hon'ble Delhi High Court in EKL Appliances (supra). 19. It is also noted that various Tribunals such as Dy. CIT v. Sona Okegawa Precision Forgings Ltd. (ITA No. 5386/Del/2010), Hero Motocorp Limited vs Addl CIT (ITA No 5130/Del/2010), ThyssenKrupp Industries India Ltd vs Addl CIT (ITA No 6460/Mum/2012), Abhishek Auto Industries Ltd. vs. CIT (ITA No 1433/Del/2009) have taken a view that RBI approval of the Royalty rates itself implies that the payments are at Arm's Length and hence no further adjustment needs to be made viewed from this angle too. 20. Furthermore, we are of the opinion that once TNMM has been applied to the assessee company's transaction, it covers under its ambit the Royalty transactions in question too and hence separate analysis and consequent deletion of the Royalty payments by the TPO in the instant case seems erroneous. We draw support from the Hon'ble Mumbai ITAT decision in Cadbury India Ltd. v. Addl. CIT ITA No 7408/Mum/2010 and ITA No.7641/Mum/2010 wherein the Hon'ble ITAT upheld the use of TNMM for Roya....
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....bsp; 35. It is, thus, seen that the royalty payment @ 3% by the assessee is at arm's length. The Technical Collaboration Agreement stands approved by the Government of India. The royalty payment has been accepted by the department as having been made by the assessee wholly and exclusively for its business purposes. For Assessment Years 2004-05 and 2005-06, such payment of royalty has been allowed by the CIT (A). As per the FEMA Regulations, royalty can be paid on net sales @ 5% on domestic sales and @ 8% on export sales. The royalty payment by the assessee falls within these limits. It also falls within the limits of payment of royalty in the automobile sector, as per the market trend. This payment of royalty is at the same percentage as that paid by other auto ancillaries in the automotive industry. Then, in 'Ekla Appliances' (supra) and in 'Ericsson India (P.) Ltd. v. DCIT', 2012-TII-48-ITAT-Del-TP, it has been held that royalty payment cannot be disallowed on the basis of the so-called benefit test and the domain of the TPO is only to examine as to whether the payment based on the agreement adheres to the arm's length principle or not. That be....