TaxTMI 
TaxTMI 
2014 (12) TMI 802
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.... disallowance of depreciation on assets purchased on slump sale. This ground of appeal is accordingly rejected as not pressed. 4. Coming to the Transfer Pricing Adjustment made by the AO, brief facts of the case are that the assessee company is engaged in the business of manufacture of automobile parts like automotive front axle, rear axle and propeller shafts for sale of these components to its group company Toyoto Kirloskar Motor Ltd., for its erstwhile vehicle Qualis and axles and propeller shafts for the Innova. It filed its return of income for the assessment year 2007-08 on 6/11/2007 declaring 'Nil' income. During the assessment proceedings u/s 143(3) of the Incometax Act, the AO observed that the assessee company had entered into certain international transactions with its associated enterprises which are as under: Description of the International Transaction INR in 000's Benchmarking Methodology Purchase of raw materials, components and consumables 6,60,217 Transactional Net Margin Method (TNMM) Purchase of Capital Assets 75,944 Payment of royalty 2,72,309 Payment for technical assistance 18,828 Payment of IT support fee 4,905 Payment of warranty claims ....
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....o furnish the details as required under the notice. The assessee furnished its reply vide letter dated 12/3/2010 stating that the royalty transaction is closely linked with other transactions and, therefore, same are aggregated under TNMM and therefore the royalty transaction is also considered to be at arm's length. However, the TPO held that the royalty transaction is a different type of transaction and is to be analyzed separately under CUP method. Thereafter, he held that the tax payer did not produce any primary evidence/documentation on how the royalty rate is fixed or the benefit received by the assessee for fixing the royalty as under: i) Domestic sales - 3% of sales ii) Export sales - 5% sales He observed that the royalty paid by the assessee is 40.76% of operating profits before royalty which is highly disproportionate to the profits earned using such technology. He further observed that even after paying such huge amounts as royalty, the assessee's margin is only 6.71% on sales, which is lesser than the average margin of 8.29% of the comparable companies (who are not paying similar royalty payments and also do not have significant intangibles) considered by the TPO. T....
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....red from the AE. Thus according to him, the finding of the TPO as well as the DRP that the assessee has not derived any benefit from use of the technology is not correct. 7. As regards TNMM being the most appropriate method for arriving at the ALP of the payment of royalty, he submitted that the technology forms integral part of the manufacturing process and the said transaction cannot be tested in isolation as the technology to manufacture is interlinked to the manufacturing process and therefore is required to be tested under TNMM. He submitted that the TPO has not provided any independent transactions which are similar or identical in nature that reflects the characteristics of the services provided by the AE's to the assessee for application of CUP method. He submitted that even assuming that CUP method is to be applied, the TPO has to conduct comparability analysis, which is an essential element of TP analysis and for failure to do so, the TP adjustment cannot be substantiated. 8. As regards the adoption of the TNMM method for the aggregation of the transactions, he submitted that the payments of royalty and technical services are under the same technical agreement and there....
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....1/Mum/2010 iii) Air Liquide Engineering India P. Ltd. (ITA No.1040/Hyd/2011) Arm's length price of royalty payment cannot be held 'Nil' i) EKL Appliances Ltd. (ITA Nos.1068/2011 & 1070/2011) ii) M/s.Air Liquide Engineering India P. Ltd. Hyderabad (ITA No.1040/Hyd/2011) iii) Abhishek Auto Industries Ltd. (ITA no.1433/Del/2009) iv) Thyssen Krupp Industries India Pvt. Ltd. (ITA No.7032/Mum/2011) Tax Authorities cannot determine the business needs i) Dresser Rand India Pvt. Ltd. vs. Addl. CIT (ITA No.8753/Mum/ 2010) ii) SC Enviro Agro India Ltd. vs. DCIT (ITA No.2057 & 2058/Mum/ 2009) 10. The learned DR, on the other hand, supported the orders of the authorities below and submitted that each of the international transactions has to be considered separately for the determination of the ALP and having regard to the peculiar nature of the royalty transactions, the TPO has rightly held that 'payment of royalty' requires separate analysis and has rightly adopted CUP method. As regards the assessee's contention that the TPO, having held that the CUP is the most appropriate method, ought to have conducted the search for comparables and, therefore, determined the ALP, he submitted th....
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....lved and would not lead to an accurate result, recourse is often had to evaluate transactions following an 'aggregation' principle. Due to increasing presence of composite contracts and 'package deals' in an MNE group, the aggregation of transactions become necessary as a composite contract may contain a number of elements including royalties, leases, sale and licenses all packaged into one deal. One would usually want to consider the deal in its totality to understand how various elements relate to each other, but the components of the composite package deal may or may not, depending on the facts and circumstances of each case, need to be evaluated separately to arrive at the appropriate transfer price. Aggregation issue may also arise when looking at uncontrolled comparables. This is because third party information is not often available at the transaction level. In such circumstances, entity level information is the only recourse available. Therefore, whether ALP-principle is to be applied on a transaction by transaction basis or on an aggregation basis depends on the facts of each case and is not universally or generally applied in all composite contracts involving multiple tra....
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....e same type, same class and of similar variety, and the enterprise does not have any other transaction which is not similar, in such a situation, the operating margins of the enterprise would be the TNMM of a class of transactions. In view of the same, we do not see any reason to take a different stand from that of the AO on this issue. 15. As regards the most appropriate method for determining the ALP of the royalty is concerned, we find that the AO has adopted the CUP method whereas the assessee has adopted the TNM Method. Now, between the two, which is the most appropriate method? Each TP method is suitable only for certain transactions. Under CUP method, higher degree of product similarity and similarity of products generally is required and it will have the greatest effect on the comparability. In addition, because even minor differences in contracted terms or economic conditions could materially affect the amount charged in an uncontrolled transaction, Comparability under this method depends on close similarity with respect to these factors or adjustments to account for any differences. Therefore, CUP method is the most direct and reliable method for determination of ALP for....
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.... or royalty rates may not pose many difficulties because CUP method could be applied with appropriate adjustment to account for material differences, if any. However, where comparable uncontrolled transactions are not available, establishing arm's length price or royalty rate may not be a straight forward exercise and may require a flexible approach that need not be strictly based on specified transfer pricing methods. Therefore, in such a situation, the perfect approach for indirectly bench marking royalty payments is to bench mark the profit margin left in the tested party, after payment of lump sum fee or royalty with the profit margins of comparable uncontrolled companies. The decisions relied upon by the learned counsel for the assessee as enumerated in the preceding paragraph No.9 above also support this view. Therefore, we are of the opinion that even if the royalty payment is to be analyzed separately, TNMM is the most appropriate method for determining the ALP. 16. To demonstrate that the price paid by the assessee towards royalty is at arm's length, the assessee has filed copies of the agreement of the AE with its other group companies as well where the rates of royalty ....
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....he international transaction as he actually finds the same and then make suitable adjustment but wholesale disallowance of the expenditure is not contemplated or authorized. Respectfully following the decision of the Hon'ble Delhi High Court, we set aside the finding of the TPO that the ALP of the transaction of royalty is 'nil'. However, for determining the ALP under the TNMM, the assessee as well as the Revenue have to search for comparable companies. Therefore, we remit this issue to the file of the AO/TPO to determine ALP of royalty by adopting TNMM after giving the assessee a fair opportunity of hearing. This issue is accordingly decided in favour of the assessee for statistical purposes. 17. The second disallowance against which the assessee is aggrieved is the disallowance of provision for slow/non-moving inventories. Brief facts relating to this issue are: the assessee had made a provision towards slow/non-moving items. During the assessment proceedings, the assessee was asked to furnish the details of such a provision. In response to the same, the assessee replied that the assessee-company carries on various types of inventories such as raw-material, components, stores, w....