TaxTMI 
TaxTMI 
2018 (9) TMI 1007
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.... (A.E) for technical knowhow. 5. Brief facts are, the assessee an Indian Company is engaged in the business of manufacturing and marketing of industrial flavours, fragrances and chemical specialties. The assessee in the year 2005 had entered into an agreement with A.E. Firmenich S.A., Switzerland for availing technical knowhow which has been renewed from time-to-time. The relevant flavours and fragrances licence agreement which is applicable to the impugned assessment year was entered into between the assessee and the A.E. on 1st April 2009. As per the terms of the agreement, the assessee was required to pay royalty @ 5% on local sales and 8% on value of export sales net-of Indian taxes. The technical knowhow is in the nature of licensor secret formula, trade secret, manufacturing procedures, methods and other technical information relating to the manufacturing, compounding, quality control, testing and servicing of the licensed products. For the impugned assessment year, the assessee had filed its return of income on 30th November 2012, declaring loss of Rs. 6,12,59,849. During the assessment proceedings, the Assessing Officer noticing that the assessee has entered into interna....
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....ernal Comparable Uncontrolled Price (CUP) to determine the arm's length price of royalty payment to the AE by restricting to 1% of the net sales. In response to the show cause notice, the assessee submitted as under:- • The entire production and sale of the assessee are relating to the formulae / concept developed by the licensor; • The formula is the root of the item produced by the assessee. In the absence of specific formula, the items cannot be produced; • The royalty payments are cost of acquisition of right to use, technical knowhow, which is directly used for manufacturing, marketing and sale; • Knowhow for which royalty is paid is indivisible part of the business operation; • The assessee does not have the formula of the products dealt in, hence, it has to use someone else's formula by paying royalty; and • Royalty payment is an acquisition cost of knowhow, without knowhow the production in which the assessee is dealing is not possible. 6. Justifying the change in the method of royalty payment from net sales to gross sales, the assessee submitted that the licensor always intended to collect....
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....nuously for more than 18 years. The Transfer Pricing Officer observed, while the assessee is paying royalty to its AE, another sister concern in India which is in similar line of business is not paying any royalty. As regards assessee's contention that TNMM is the most appropriate method, the Transfer Pricing Officer referring to a decision of the Tribunal, Mumbai Bench, in case of Skol Breweries Ltd. v/s ACIT, TS-10-ITAT-2013 observed that CUP method for bench marking royalty payment should be preferred. Thus, the Transfer Pricing Officer ultimately held that the payment of royalty in the given facts and circumstances of the case is not justified, hence, has to be disallowed under section 37(1) of the Act. Further, he observed, considering that the assessee might be getting some technical inputs to run his manufacturing plant, the assessee would be required to pay 10% of the royalty which was paid during the year. Therefore, he determined the arm's length price of the royalty payment for availing technical knowhow at Rs. 2,01,19,124. Without prejudice to the aforesaid observations, the Transfer Pricing Officer held that if at all assessee's claim of royalty payment is to be al....
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....arch and development activities are being carried out by the A.E. and the assessee is using intangibles developed by the AE. Referring to different clauses of the agreement, the learned Authorised Representative submitted, royalty has to be paid on yearly basis, since, the agreement gives the assessee a right to manufacture the products by utilising the technical knowhow of the AE. He submitted, if the assessee stops paying royalty, it will have to stop all its manufacturing activity. In this context, he specifically drew our attention to Article-2, 3 and 5 of the agreement. Referring to the transfer pricing study report, the learned Authorised Representative submitted, the AE in Switzerland looks after scientific research for the whole group which enables it to discover over 1,000 new molecules and chemical substances every year, out of which, the most effective are marketed commercially. Looking at the demand of the products thousands of different compositions are created and produced which requires continuous and intensive research. He submitted, all intellectual property rights (IPR) remains with the A.E. in Switzerland. The learned Authorised Representative submitted, while de....
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....te transaction, it cannot be aggregated. In this context, he relied upon the decision of the Hon'ble Punjab & Haryana High Court in Knorr Bremse India Pvt. Ltd. v/s CIT, [2016] 380 ITR 307 (P&H). The learned Departmental Representative submitted, the assessee has determined the arm's length price on the basis of a circular issued by the Ministry of Commerce, which is also not in accordance with the statutory provisions. He submitted, if the ad-hoc adjustment made by the Transfer Pricing Officer is held to be not in accordance with the statutory provision, the alternative bench marking made by the Transfer Pricing Officer applying CUP method should be upheld. The learned Departmental Representative submitted, since, the international transaction between the assessee relates to payment of royalty to the AE, CUP is the most appropriate method. Finally, the learned Departmental Representative submitted, if there is any deficiency in the order of the Transfer Pricing Officer, it can be restored back to him for determining arm's length price denovo by applying a correct method. In support of his contention, the learned Departmental Representative relied upon the following dec....
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.... of royalty. Pertinently, on a perusal of the order of the Transfer Pricing Officer, it is evident that the Transfer Pricing Officer has raised doubt / suspicion with regard to payment of royalty basically for the reason of business expediency. The Transfer Pricing Officer has observed, since the assessee was availing the technical knowhow from the AE and paying royalty since 1997, it does not require any further technical help from the AE with regard to its manufacturing activity of industrial flavours and fragrances. Thus, the Transfer Pricing Officer has ultimately concluded that the royalty payment needs to be disallowed under section 37(1) of the Act in the absence of any evidence to suggest transfer of technical knowhow during the year. Having held so, the Transfer Pricing Officer again observed that since the assessee might be getting some technical inputs to run his manufacturing plan, he is required to pay 10% of the royalty paid to the AE during the year. Accordingly, he determined the arm's length price of the royalty payment at Rs. 2,01,19,124 as against the amount of Rs. 18,10,72,120 actually paid by the assessee. Thus, it is evident that the Transfer Pricing Offic....
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....eading of the aforesaid provisions, the duty of the Transfer Pricing Officer is restricted only to the determination of arm's length price of an international transaction between two related parties by applying any of the methods prescribed under section 92C of the Act r/w rule 10B of the Rules. Thus, there is no provision under the Act empowering the Transfer Pricing Officer to determine the arm's length price on estimation basis, that too, by entertaining doubts with regard to the business expediency of the payment and in the process stepping into the shoes of the Assessing Officer for making disallowance under section 37(1) of the Act. This, in our considered opinion, is not in conformity with the statutory provision, hence, unacceptable. The Transfer Pricing Officer is duty bound to determine the arm's length price of the international transaction by adopting one of the method prescribed under the statute and cannot deviate from the restrictions / conditions imposed under the statute. The Hon'ble Jurisdictional High Court in CIT v/s Johnson & Johnson Ltd., ITA no.1030/2014, dated 7th March 2017, while dealing with identical issue of determination of arm's le....
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....ngoing technical assistance on process and product improvement to be provided or any other services as specified in the agreement, including any technology or services provided, assessee shall pay to RAK, UAE royalty equivalent to 3% of the net ex-factory sale price of the products on both domestic as well as export sales during the tenure of the royalty agreement. 8. From the clauses of the royalty agreement referred to above, it becomes clear not only RAK, UAE, will provide the technical know-how and assistance for manufacturing products, but, assessee will also have to manufacture by using such technical know-how, assistance in accordance with international standards and guidelines set by RAK, UAE. For using such technical know-how, assistance, etc. assessee is required to pay royalty of 3% to its AE both on domestic and export sales. Department has not denied existence of royalty agreement nor the fact that payment of royalty at 3% is as per the terms of the agreement. TPO has also not disputed the fact that there is transfer of technical know-how and assistance from the AE to assessee. What the TPO disputes is the quantum of royalty paid. As can be seen from the TP re....
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....oned of undertaking an independent analysis under TNMM for selecting comparables and determining ALP. However, even after repeatedly scanning through his order, we failed to find any such analysis being done by him. Similarly, though in para 5.1.1, ld. DRP has observed that TPO has benchmarked intangible transactions by using CUP, but, the order passed by TPO does not support such conclusion. It is an accepted principle of law that TPO has to determine the ALP by adopting any one of the methods prescribed u/s 92C of the Act. Mode and manner of computation of ALP under different methods have been laid down in rule 10B. Even, assuming that TPO has followed CUP method for determining ALP of royalty payment, as held by ld. DRP, it needs to be examined if it is strictly in compliance with statutory provisions. Rule 10B(1)(a) lays down the procedure for determining ALP under CUP method. As per the said provision, TPO at first has to find out the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions. Thereafter, making necessary adjustments to such price, on account of differences between the internat....
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....lty paid by the assessee in respect of exports sale and other income. We are unable to agree with this strange method followed by the TPO to make a TP adjustment in respect of royalty payment which is not sustainable either in law or on the facts of the case. She has neither rejected the method followed by the assessee to bench-mark the transaction in respect of payment of royalty nor has been adopted any recognized method to determine the ALP of the said transactions. The approval of SIA adopted by the TPO as basis to make TP adjustment in respect of royalty payment was untenable and even going by the said basis wrongly adopted by the TPO, no TP adjustment in respect of royalty payment was liable to be made. As per the said basis, the net sales of the assessee after excluding export sale and other income were to the extent of Rs. 1118.70 crores and the royalty paid thereon at Rs. 24.38 crore being less than the rate of 3.5% approved by SIA, there was no case of any excess payment made of royalty by assessee than approved by SIA to justify its disallowance by way of TP adjustment. In our opinion, the ld. CIT (A) could not appreciate these infirmities in the order of the TPO despite....
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....is concerned, it is not in dispute that the assessee offered three comparables with an average royalty payment of 3.65% as against its own rate of royalty at 3%. Significantly, the TPO rejected these comparable on the ground that they were US based, while the AE of the assessee was UAE based. Having rejected these comparables, it was for the TPO to come up with other comparables, it was for the TPO to come up with other comparables, it was for the TPO to come up with other comparables so as to justify reduction of the royalty payment. However, no such exercise was undertaken by the TPO determined that the reason for the same was increased marketing along with offer of discounts and that there was no justification for payment of royalty at 3% to the AE by the assessee. This reasoning is without legal basis of law as it is not for the TPO to decide the best business strategy for the assessee. In WALCHAND AND CO. PRIVATE LTD. the Supreme Court observed in the context of the Income-tax Act, 1922 that when a claim is made for an allowance by the assessee, the income tax authorities have to decide whether the expenditure claimed as an allowance was incurred voluntarily and on gr....
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.... there is no dispute that the assessee by virtue of a license agreement entered with the AE from past several years had been availing technical knowhow for utilization in manufacturing of flavours and fragrances. It is also evident on record, the assessee does not undertakes any research and development activity and all research and development activities are carried out by the AE in Switzerland. All intellectual property right in relation to R&D activities remains with the AE. It is also a fact on record that the assessee is paying royalty to the AE for availing technical knowhow from the very inception of its manufacturing activity. Therefore, only because the manufacturing activity is being carried on from past several years, it does not mean that the assessee would not require the technical knowhow of the AE, hence, there is no necessity for paying royalty to the AE. More so, when the Department accepts availing of technical knowhow while allowing a part of royalty even on estimate basis. Therefore, keeping in view the relevant statutory provisions and the principles laid down in the judicial precedents discussed herein above, we hold that determination of arm's length pric....
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....ore the issue to Transfer Pricing Officer for fresh determination of arm's length price is unacceptable. Thus, on overall consideration of facts and material on record, we hold that the adjustment made to the arm's length price of royalty payment is unsustainable; hence, the addition made in this regard is deleted. This ground is allowed. 16. In ground no.2, the assessee has challenged the addition made of Rs. 11,34,38,330, on account of adjustment made to the arm's length price of payment to the AE towards availing Information Systems (IS) services. 17. Brief facts are, in the course of proceedings before him, the Transfer Pricing Officer noticed that the assessee has paid an amount of Rs. 12,96,43,330, for availing Software Services, out of which, the assessee has capitalized an amount of Rs. 5,34,68,651, and claimed the balance amount of Rs. 7,61,74,677, as revenue expenditure. After calling for necessary details relating to the payment made, use of software and actual services provided by the AE, basis for allocation of cost to the assessee, cost incurred by the A.E. and evidences for third party payment made by the AE the Assessing Officer alleged that the as....
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....o the best judgment. Accordingly, the Transfer Pricing Officer proceeded to quantify the arm's length price of the payment made by stating that the number of man hours rendered by the employees towards rendering of services to the assessee is two man hour per day i.e., 365 man hour per year. Applying the man hour rate of Rs. 8,05,000 per hour, which according to the Transfer Pricing Officer can be considered as a CUP, he determined the arm's length price of the services availed by the assessee at Rs. 62,05,000. In addition, the Transfer Pricing Officer estimated an amount of Rs. 1,00,00,000 towards cost of software to be paid annually by the assessee. Thus, he determined the arm's length price of the services rendered by the AE at Rs. 1,62,05,000 as against the payment made by the assessee at Rs. 12,96,43,330. Accordingly, he made an adjustment of Rs. 11,34,38,330. While, framing the assessment order the Assessing Officer added back the same amount to the income of the assessee. 18. Being aggrieved, the assessee filed appeal before the DRP. However, the DRP did not find any merit in the submissions of the assessee and upheld the estimation made by the Transfer Pricin....
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....ct. Further, the learned Authorised Representative submitted, though, similar payment was made by the assessee in assessment year 2011-12, no adjustment was made by the Transfer Pricing Officer. Thus, he submitted, the adjustment made to arm's length price by the Transfer Pricing Officer deserves to be struck down. In support of his contention, the learned Authorised Representative relied upon the following decisions:- i) McCann Erickson India Pvt. Ltd. v/s ACIT, ITA no.587/Del./ 2011, dated 08.06.2012; ii) TNS India Pvt. Ltd. v/s ACIT, [2014] 39 CCH 032 (Hyd.); iii) Dresser-Rand India Pvt. Ltd. v/s ACIT, [2011] 141 TTJ (Mum.) 2010; iv) DCIT v/s M/s. UCB India Ltd., ITA no.1218/Mum./2014, dated 27.04.2016; v) AWB India Pvt. Ltd. v/s DCIT, ITA no.6480/Del./2012, dated 13.10.2014; and vi) Merck Ltd. v/s DCIT, [2014] 148 ITD 513 (Mum.); and vii) DCIT v/s M/s. Diebold Software Services Pvt. Ltd., ITA no. 4347/Mum./2012, dated 02.04.2014. 20. The learned Departmental Representative relying upon the observations of the DRP and the Transfer Pricing Officer submitted that the assessee did not file proper documentary evid....
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....the Transfer Pricing Officer disbelieves is the quantum of payment. Accordingly, he has proceeded to estimate the price of the services rendered by the AE at Rs. 1,62,05,000. Though, the Transfer Pricing Officer has observed that he has applied CUP method for determining the arm's length price, however, he has not brought on record even a single comparable to support the arm's length price determined by him even on estimate basis. The estimation of service charges on so called man hour basis is without any supporting material. Similarly, the estimation of cost of software at `. 1 crore is without any basis. Thus, it is very much clear that the determination of arm's length price by the Transfer Pricing Officer is not as per any one of the methods prescribed under section 92C of the Act r/w rule 10B. As discussed elsewhere in this order, such determination of arm's length price on ad-hoc / estimation basis is not permissible under the scheme of the Act as the Transfer Pricing Officer is duty bound to determine the arm's length price by following any one of the most appropriate method prescribed under the statute. It is relevant to observe, the DRP has approved th....