TaxTMI 
TaxTMI 
2014 (12) TMI 10
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....he Ld Commissioner of Income-tax (Appeals)-l ('CIT(A)') has erred on facts and in law in holding that the Assessing Officer ('AO') had validly issued the notice under section 148 of the Act. 2. The Ld CIT(A)-I has further erred on facts and in law: * in holding that the royalty amount (in connection with provision of technology) needs to be computed by deducting the cost of bought out components from the sales value, thereby rejecting the methodology adopted by the appellant for computing royalty payable to the associated enterprise. * in confirming the disallowance of excess provision of royalty payable to the associated enterprise the extent of Rs. 1,954,132 under section 40A(2b) of the Act." 4. The appellant, before us, is a company incorporated under the provisions of the Indian Companies Act, 1956 and is, inter-alia, engaged in the business of manufacture and sale of organic peroxides, which acts as initiators in polymerization reactions and are used in making of polymers like PVC, LDPE, HDPE, Polyacrylite, ABS, etc.. For the assessment year under consideration i.e. 2001-02, it filed a return of income on 29.10.2001 declaring total income of Rs. 4,7....
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....s resulting in excess royalty of Rs. 19,54,132/-. As per the Assessing Officer cost of certain raw materials, which according to him were mere constituent material and thus were to be understood as 'bought out components' were liable to be reduced from the value of sales to arrive at net sales value on which royalty @ 5% is to be computed. The CIT(A) has also affirmed the action of the Assessing Officer against which the assessee is in appeal before us. 7. On this aspect, it was a common point between the parties that similar stand of the Assessing Officer, based on the order of the Transfer Pricing Officer in assessment years 2006-07 and 2007-08 was a subject- matter of consideration of the Tribunal in assessee's own case vide ITA No.1477/PN/2010 and ITA No.1659/PN/2011 dated 11.02.2014. As per the Tribunal, the methodology adopted by the Revenue to rework the net sales value for the purposes of computing royalty payable was not justified. In this context, the relevant discussion in the order of the Tribunal dated 11.02.2014 (supra) reads as under :- "17. Even otherwise, the action of the TPO in considering certain raw materials used in the production process as ....
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....raw material and the finished goods have also been brought out as follows :- Criteria Chloroformate Finished Good storage conditions miscible/reactivity in water purity application appearance Hazard class ambient immiscible with water and reacts 98% to manufacture organic chemicals clear liquid Toxic (6.1) -15 Deg C max miscible with water 50 to 60% initiator to PVC polymerization white emulsion Oxidising agent (5.2) 19. On the basis of the above, it was sought to be canvassed that the chemicals sought to be classified by the TPO as constituent material are indeed raw materials. It is canvassed that the raw materials used by the assessee in its production process including the so-called 'constituent chemicals' classified by the TPO, undergo a chemical reaction in the manufacturing process, which is irreversible. It is further explained that the properties and usage of the finished goods achieved, namely, polymerization initiators, is quite, distinct from the raw materials consumed and none of the raw materials, including the so-called 'constituent chemicals' used in the manufacture of finished goods, can be retrieved after the end of t....
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....nt is a manufacturing company, in which it is using imported raw materials, which are mixed and used to manufacture the final product. Should this raw materials also be treated at par with the imported components/ bought-out components? and be deducted from sale price to calculate royalty. Would highly appreciate your guidance on the same. Reply : Dear sir, In our opinion, No. Regards BB Sharma. Query : Thanks for the reply. Just to confirm your view on computation, does it mean that only bought out components on which no further processing is required in the company and are directly fitted into the final products are to be subtracted from the selling price? Your guidance in this regard would be highly appreciated. Reply : Dear sir: Your understanding seems to be correct Regards B B Sharma" 23. From the aforesaid, it is clear that what is liable to be considered as standard bought-out components are such material on which no further processing is required and are directly fitted into the final product; and, cost of such material only needs to be deducted from the sale price to compute the royalty payable. Applying the said clarification to the present situation, conside....
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....se considered by us in the appeal for assessment year 2001-02 (supra) in the earlier paragraphs. Thus, our decision in the appeal for assessment year 2001-02 (supra) would apply mutatis-mutandis in this appeal also. 14. In the result, the appeal of the assessee for assessment year 2002-03 vide ITA No.668/PN/2012 is partly allowed in the same manner as the appeal for assessment year 2001-02. 15. Now, we may take-up the appeal of the assessee in ITA No.2181/PN/2012 for assessment year 2008-09, which is directed against the order of the Dy. Commissioner of Income Tax, Circle- 1(1), Pune (in short 'the Assessing Officer') passed u/s 143(3) r.w.s. 144C(1) of the Act dated 03.10.2012, which is in conformity with the directions given by the Dispute Resolution Panel, Pune (in short 'the DRP') dated 05.09.2012. 16. In this appeal, the Grounds of Appeal raised by the assessee read as under :- "The Ld. Assessing Officer ('AO'), pursuant to the directions given by the Ld. Dispute Resolution Panel ('DRP'), erred in ruling that the transactions pertaining to royalty payment, export of certain finished goods and provision of marketing and sales support ....
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....ticed that assessee had undertaken certain international transactions with its associated enterprises, which were subject to the transfer pricing analysis by the TPO as a consequence of a reference made by the Assessing Officer in terms of section 92CA(1) of the Act. The TPO vide his order dated 17.10.2011 passed u/s 92CA(3) of the Act proposed an adjustment of Rs. 97,43,577/-towards transfer pricing adjustment to the stated values of international transactions undertaken with the associated enterprises so as to bring them at an arm's length price. The Assessing Officer has thereafter proposed a draft assessment order u/s 143(3) r.w.s. 144C(1) of the Act dated 20.12.2011 proposing to compute the arm's length price of the international transactions by making adjustment of Rs. 97,43,577/-. The assessee filed objections before the DRP against the draft assessment order proposed by the Assessing Officer. The DRP vide its order dated 05.09.2012 disposed of the objections raised by the assessee and accordingly the Assessing Officer passed the final assessment order giving effect to such directions. The additions made by the Assessing Officer on account of the transfer pricing adj....
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....resaid additions have been made in the same manner as was in assessment year 2006-07, which has been a subject-matter of consideration by the Tribunal vide order dated 11.02.2014 (supra). 20. In the above background, the learned counsel for the assessee has referred to the facts of the present year to point out that the stand of the Revenue as well as the submissions and material furnished by the assessee to the lower authorities in this year stand on the similar footing as was in assessment year 2006-07. The learned CIT-DR, while referring to the order of the authorities below has not controverted the factual matrix that the issues and the rival stands are similar to those in the assessment year 2006-07. Thus, the issues in the instant year are liable to be decided in the light of the precedent in the assessee's own case vide order of the Tribunal dated 11.02.2014 (supra). 21. The first issue is with regard to an addition of Rs. 79,96,489/- made on account of international transactions of payment of royalty to the associated enterprises. In this context, we reproduce hereinafter the following portion of the order of the Tribunal dated 11.02.2014, which brings out the con....
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....the royalty paid to the AE for export sales @ 8% is not at an arm's length price for reason that royalty paid by another Akzo group company i.e. Tianjin Akzo Nobel Peroxides, China (hereinafter referred to as 'TANPC') to the same AE was @ 5%; and, therefore the TPO adopted the rate of 5% to determine the arm's length royalty payable by assessee to the AE on the export sales. The aforesaid position has since been affirmed by the DRP also. 8. On both the aforesaid aspects, the learned counsel for the assessee vehemently submitted that the lower authorities have erred in law as well on facts. Firstly, it is contended that the expression 'Net Sales', was required to be interpreted in terms of the standard terms and conditions prescribed by the Reserve Bank of India, which are applicable to all agreements pertaining to royalty payments on technology transfers to Indian companies. In this regard, our attention was drawn to the meaning of expression 'Net Sales' provided in para 3.3 of Chapter III of the Manual for Foreign Direct Investment Policy & Procedures issued by Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, Governme....
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.... have been placed in the Paper Book at pages 376 to 386 of the Paper Book for assessment year 2006-07 and at page 186 of the Paper Book for assessment year 2007-08 respectively. In this context, it is sought to be made out that the period of the agreement and the products covered are different inasmuch as the Indian agreement is for seven (7) years whereas the China's agreement is for twenty (20) years. The products covered under the two agreements are also different inasmuch as the Indian agreement has 22 products whereas China's agreement has 33 products. It is submitted that where the period and the products covered are different, such transactions cannot be considered as comparable and reference has been made to the decision of the Pune Bench of the Tribunal in the case of Kirloskar Ebara Pumps Ltd. 47 SOT 20 (Pune) in this regard. Thirdly, it is sought to be made out that there is an error in the addition made on account of royalty inasmuch as a sum of Rs. 3,07,170/- has been added in excess, even if the stand of the TPO was liable to be upheld. 10. On the other hand, the learned CIT(DR) appearing for the Revenue has referred to the orders of the authorities below i....
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....payment by TANPC to its AE @ 5% was a perfect comparable while applying the CUP method and thus the action of the TPO is sought to be justified. 11. We have carefully considered the rival submissions on this aspect. Before proceeding to adjudicate the addition of Rs. 91,66,061/- made on account of royalty payment, it would be relevant to note the pertinent facts. The appellant company is paying royalty to the AE for transfer of technology in terms of a Foreign Technology Collaboration agreement, which has been duly approved by the Government of India, a copy of such agreement is placed at pages 259 to 261 of the Paper Book. In terms of the said agreement, royalty payments are authorized on domestic sales and on export sales @ 5% and 8% respectively of 'Net sales', subject to taxes. The items of manufacture covered by the foreign collaboration are 'polymerization initiators', which is a product manufactured by the assessee for use as catalyst in manufacturing of polymers. The approval prescribes that the royalty payable shall be calculated in accordance with the provisions of the Foreign Exchange Control Manual of RBI and other subsisting instructions of Govt. of ....
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....net sales, subject to taxes", as per the approval of Govt. of India. 12. Before we proceed further on this aspect, it would be appropriate to refer to a pertinent point asserted by the appellant, which is to the effect that the amount of royalty remitted to the foreign collaboration, i.e. the AE, is as per the provisions of Foreign Exchange Control Manual of RBI. Notably, the approval by the Department of Industrial Policy & Promotion (Secretariat for Industrial Assistance) dated 11.02.2005 itself prescribes that royalty shall be payable in accordance with the provisions of Foreign Exchange Control Manual of RBI and other subsisting instructions of the Govt. of India/Reserve Bank of India. There is no material on record to suggest that the calculation of royalty made by the assessee has been found to be violative of the respective provisions of FEMA or other subsisting instructions of the Govt. of India/Reserve Bank of India. In this background, a moot question which arises is whether the TPO is competent to rework the 'royalty payment' on the basis of his interpretation of the meaning of expression 'Net Sales', for the purpose of determining its 'arm's l....
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....see to the associated enterprise was unjustified and the arm's length price of the transaction should be taken as 'NIL'. The Hon'ble High Court disapproved the action of the TPO, and after referring to the OECD's transfer pricing guidelines observed that the TPO was expected to examine the international transactions as he actually found them. In our considered opinion, the aforesaid parity of reasoning laid down by the Hon'ble Delhi High comes into play in the present fact-situation also, as our following discussion would show. 15. In the case before the Hon'ble Delhi High Court, the TPO had applied the CUP method while examining the payment of brand fee/royalty, which also is the position in the case before us. The Hon'ble High Court referred to the OECD's "transfer pricing guidelines" for multinational enterprises and tax administrations, and reproduced paras 1.36 to 1.41 of such guidelines, which provide for "recognition of the actual transactions undertaken". Thereafter, the Hon'ble High Court opined as under :- "17. The significance of the aforesaid guidelines lies in the fact that they recognise that barring exceptional cases, the....
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....essee is justified and falls within the exceptions provided in the OECD guidelines which permit the TPO to re-write the transaction or to disregard actual transactions. Considered in the context of the OECD guidelines which have been exhaustively referred by the Hon'ble Delhi High Court in the case of EKL Appliances Ltd. (supra) the impugned situation does not fit into the two exceptions. Firstly, neither the Revenue has alleged and nor is there any material on record to suggest that the economic substance of the impugned transaction differs from its form. Secondly, there is no material on record to suggest that there is an arrangement between assessee and the AE made in relation to the impugned transaction which would differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. We say so for the reason that the entire gamut of royalty payment by the assessee to the AE is in terms of the Foreign Technology Collaboration agreement, which is duly approved by Govt. of India in terms of its Policy, which is applicable across the spectrum. Moreover, it is not the case of the TPO or even of the Revenue before us that the royal....
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....f raw materials, in-process checks are the other key factors Reaction : The reaction is irreversible in nature. Only thermal decomposition is possible. Decomposition : The product can decompose at certain temperature. Such decomposition can produce products like Carbon Dioxide (CO2), Carbon Monoxide and 2- ethylhexanol. However none of the original raw materials like Hydrogen Peroxide or Chloroformates can be retrieved." 18. Further, the difference between the key raw material and the finished goods have also been brought out as follows :- Criteria Chloroformate Finished Good storage conditions miscible/reactivity in water purity application appearance Hazard class ambient immiscible with water and reacts 98% to manufacture organic chemicals clear liquid Toxic (6.1) -15 Deg C max miscible with water 50 to 60% initiator to PVC polymerization white emulsion Oxidising agent (5.2) 19. On the basis of the above, it was sought to be canvassed that the chemicals sought to be classified by the TPO as constituent material are indeed raw materials. It is canvassed that the raw materials used by the assessee in its production process including the so-ca....
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....low Up Computation of royalty Query : Dear Sir, One of our Corporate client wants to remit royalty (No Technical Knowhow paid and royalty rate is 5%, hence covered under Automatic route) to its parent company abroad. For calculation of royalty, among other deductions, landed cost of imported components, standard bought out components used in the manufacture of the final product have to be reduced from the sale price, on which royalty is payable. The query is: Our client is a manufacturing company, in which it is using imported raw materials, which are mixed and used to manufacture the final product. Should this raw materials also be treated at par with the imported components/ bought-out components? and be deducted from sale price to calculate royalty. Would highly appreciate your guidance on the same. Reply : Dear sir, In our opinion, No. Regards BB Sharma. Query : Thanks for the reply. Just to confirm your view on computation, does it mean that only bought out components on which no further processing is required in the company and are directly fitted into the final products are to be subtracted from the selling price? Your guidance in this regard would be highly appr....
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....ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price in respect of the property transferred or services provided in the international transaction;" 25. The aforesaid three steps would reveal that the action of the TPO in the present case is contrary to the prescription contained in sub-clause (i) of clause (a) of sub-rule (1) of rule 10B of the Rules. Ostensibly, in terms of sub-clause (i), the price charged or paid in a "comparable uncontrolled transaction" is to be identified for the purpose of determining the arm's length price of the international transaction being tested. It is starkly evident that in the present case, the comparable transaction picked-up by the TPO, namely, royalty payment by TANPC to the AE is a transaction between two related/associated enterprises and therefore it is a controlled transaction and not a "uncontrolled transaction". Such a tran....
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....d value of export sales corresponding to the difference between the price charged to the third parties in India and that charged to the associated enterprises. Thus, an adjustment of Rs. 14,63,820/- has been worked out. 24. Briefly put the objection of the assessee to the action of the TPO are two fold. Firstly, according to the assessee, the TPO was not justified in applying the CUP method whereas assessee had applied the TNM method for determining the arm's length price in relation to the transactions of export of finished goods to the associated enterprises. Secondly, it was submitted that the transaction of export to the associated enterprises and domestic sale of the product to third parties cannot be considered as comparable on account of differences in volumes, geographical factors, functions and risks involved. Both the aforesaid points were raised by the assessee against similar action of the TPO in assessment year 2006-07 also. The rival stand has been considered by the Tribunal in its order dated 11.02.2014 (supra), and the relevant discussion in the order of the Tribunal dated 11.02.2014 (supra) reads as under :- "31. Factually speaking, in the present case as....
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....s placed the copy of export invoices/delivery details of the product exported to the AE. The AE on its part, sold the goods to the ultimate consumer at a price equivalent to Rs. 288/- per kg., after buying from the assessee at Rs. 239/- per kg.. The local sale, on the other hand, is claimed to have been made to a customer, who has utilized it for its own consumption. Fourthly, assessee has pointed out that the sales to third parties require certain level of additional costs, viz. selling, marketing, payment follow-up etc., which is not so in case of export to the AE. Fifthly, it is pointed out that the export made to the AE has resulted in an indirect economic benefit by way of obtaining advance license for duty free imports. A rough calculation in this regard has been furnished at the time of hearing in terms of which it is pointed out that such economic benefit was to the tune of Rs. 10-11 per kg.. The aforesaid points brought out by the assessee, in our view, are bonafide grounds to permit adjustment to the comparable uncontrolled price being considered in order to benchmark the transaction of export. Notably, such adjustment is called for, having regard to the provisions of sub....
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.... to the AE to Rs. 5,49,000/- instead of Rs. 11,34,000/-. Thus, on this aspect, assessee partly succeeds. " 25. In the light of the aforesaid, it is evident that the Tribunal did not interfere with the action of the TPO in benchmarking the impugned international transactions by applying the CUP method. So however, with regard to the alternative plea of the assessee seeking adjustment in the price charged from the domestic buyers so as to account for differences with the international transactions of export of products to the associated enterprises was accepted so as to facilitate their comparability. At the time of hearing, learned counsel for the assessee furnished a working, based on the order of the Tribunal dated 11.02.2014 (supra) whereby an adjustment was made to the price charged to the third parties so as to make it comparable with the price charged from the associated enterprises. In terms of the said working, it is submitted that in the instant year, the adjusted price would compare favourably with the export price charged from the associated enterprises and therefore no further adjustment is required in export price to bring it to an arm's length price. Since, the ....
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....h and intelligence gathering, which is quite distinct from the activity of marketing of products. Therefore, while the TPO was justified in rejecting M/s Gaur & Nagi Ltd. and Agrima Consultants International Ltd. as being functionally incomparable, however in the case of IDC (India) Ltd. the functional profits is different as it is engaged in the field of marketing activity alone. Perhaps, the above distinction escaped the attention of the TPO for the year under consideration because in the next assessment year 2007-08 the said concern has been accepted as functionally comparable. Thus, for the aforesaid reasons, we hold that assessee is justified in claiming that concern IDC (India) Ltd. be considered as a comparable for the purposes of benchmarking international transactions of Intending commission and marketing support fees. The TPO is directed to re-work the adjustment, if any on this aspect and accordingly assessee partly succeeds." 27. Ostensibly, in assessment year 2006-07 (supra) the Tribunal approved the stand of the TPO in excluding M/s Agrima Consultants International Ltd. from the list of comparables on the ground that the said concern was functionally distinct. Ther....