DCIT CIRCLE 711 BANGALORE, BANGALORE vs. TOYOTA KIRLOSKAR MOTORS PRIVATE LIMITED, BANGALORE

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ITTPA 644/BANG/2023Status: DisposedITAT Bangalore21 December 20238 pages
AI SummaryPartly Allowed

What did the Tribunal hold?

The Tribunal held that separate benchmarking of royalty payment is not required when the assessee has adopted the TNMM method at the entity level, which includes royalty as part of operating costs. This decision was based on the consistent view of the coordinate bench of the Tribunal in the assessee's own case for earlier assessment years (AYs 2012-13 and 2014-15), which found that if the net profit margin is tested at the entity level, the individual components are implicitly at arm's length. The Tribunal followed the precedent and directed the AO/TPO to delete any adjustment proposed for royalty as a separate international transaction. Consequently, the grounds relating to the Arm's Length Price (ALP) computation of royalty were rendered academic and left undecided. For the revenue's appeal concerning testing expenses (R&D), the Tribunal held that since the assessee's appeals were allowed on the issue of separate benchmarking of royalty, this issue also became purely academic and did not require separate adjudication. The Tribunal allowed the assessee's appeals partly and dismissed the revenue's appeals.

What were the facts?

The assessee, Toyota Kirloskar Motor Private Ltd., is a subsidiary of TMC, manufacturing and selling vehicles in India, and also importing and selling certain car models. It purchases spares/components from Associated Enterprises (AEs) and pays royalty for technology from TMC. The appeals concern Assessment Years (AYs) 2015-16 and 2016-17, challenging orders of the CIT(Appeals). The assessee's Transfer Pricing (TP) study adopted a TNMM approach at the entity level, treating royalty as part of operating costs. The TPO, however, separately benchmarked royalty and computed an adjustment. The CIT(Appeals) upheld the separate benchmarking of royalty but directed the exclusion of R&D expenses from the royalty ratio calculation for the assessee and the use of manufacturing sales as the denominator for both assessee and comparables.

What were the issues?

1. Whether the separate benchmarking of royalty payment as an international transaction is permissible, given the assessee's adoption of TNMM at the entity level which includes royalty as part of operating costs? (Question of law) 2. Whether the CIT(Appeals) was correct in holding that testing expenses, characterized as R&D expenses, do not involve the use of know-how from the AE without verifying the nature of expenses? (Question of mixed law and fact) Assessee's Contention (Issue 1): The assessee argued that since its TNMM at the entity level considers royalty as part of operating costs and the net profit margin is tested at arm's length, the individual components like royalty are implicitly at arm's length. It relied on the Bangalore Tribunal's decisions in its own case for AYs 2013-14, 2012-13, and 2014-15, which held that separate benchmarking of royalty is not permissible when TNMM is applied at the entity level. The assessee contended that if this issue is decided in its favour, the grounds related to ALP computation of royalty become academic. Revenue's Contention (Issue 1): The revenue relied on the orders of the lower authorities and argued that since the assessee adopted TNMM and the TPO accepted the method, the TPO did not make a separate adjustment for royalty, implying the issue should not be raised. (Note: The judgment later clarifies the TPO did compute an ALP for royalty, but no separate adjustment was proposed).

Which sections of the Income-tax Act were involved?

Section 234B

AI-generated summary — verify with the full judgment below

Income Tax Appellate Tribunal, “C” BENCH : BANGALORE

Before: SHRI GEORGE GEORGE K. & SHRI LAXMI PRASAD SAHU

For Appellant: Shri Padamchand Khincha, CA
For Respondent: Dr. Manjunath Karkihalli
Hearing: 29.11.2023Pronounced: 21.12.2023

Per Bench These cross appeals are filed by the assessee and the revenue against the separate DIN & Orders dated 30.03.2023 & 31.03.2023 of the CIT(Appeals)-12, Bangalore for the AYs 205-16 & 2016-17 respectively.

2.

The assessee, subsidiary of TMC, is a private limited company and is set up in India to manufacture and sell MUV and Passenger car. It has obtained license & technology to manufacture and sell passenger vehicles from TMC. It also imports certain models of cars as CBU and sells them in India. The assessee purchases various spares/components from AEs, which form part of these vehicles and are sold as spare parts as part of post sales service activity. The assessee pays royalty for technology transferred by TMC.

For AY 2015-16, a brief summary of the TP analysis conducted 3. by the assessee and the TPO are as under:-

Assessee’s TP Study TP Order Particulars (Pg 114-227 of PB-1) (57-72 of Appeal Papers) TNMM at entity level after aggregating all the international transactions (Para 12 at Page 72 of TNMM at entity level after Appeal Papers). Most appropriate aggregating all the However, TPO has concluded method international transactions that royalty should be (Page 188 to 209 of PB-1) separately benchmarked (Page 64 to 68 of Appeal Papers)

IT(TP)A Nos.421 & 422, 643 & 644/Bang/2023 Page 3 of 8 The TPO has accepted all the Force Motors, Ashok international transactions to Leyland, and SML Isuzu be at ALP except royalty. selected as Comparables In relation to Royalty (Page 204 of PB-1). Average payment, the TPO has margin of comparables was Computation of compared Royalty to Sales computed at 2.76% and that ALP ratio of the Appellant with of Appellant was computed at Average R&D expense plus 9.47% (Page No.208 and 209 Royalty ratio of Force of PB-I). Accordingly, Motors, Ashok Leyland and international transactions SML Isuzu (Page 71 & 72 of were concluded at ALP. Appeal Papers).

4.

Briefly stated, the TPO adopted net manufacturing sales as the denominator for the assessee, whereas in case of comparables, the TPO adopted net manufacturing plus trading sales as denominator. Further, the technical know-how fees and testing charges (classified as R&D expenses) were included in royalty to calculate the royalty to sales ratio. The ratio of was calculated at 3.62%.

5.

In case of comparables, the average R&D expenses plus royalty expenses divided by net sales ratio was calculated at 2.04%. Accordingly, TP adjustment was computed at Rs.225,43,63,920/- in respect of royalty payment. As there was error in computation, the TPO passed a rectified order wherein the TP adjustment was recomputed to Rs.196,65,18,080/-.

6.

The assessee filed appeal before the CIT(Appeals) and submitted detailed written submissions against the additions made by the AO. The CIT(A) rejected combined transaction approach of the assessee and upheld the action of TPO to separately benchmark the royalty

IT(TP)A Nos.421 & 422, 643 & 644/Bang/2023 Page 4 of 8 payment. With respect to computation of ALP for royalty, the CIT(A) rejected assessee’s contention of inclusion of Tata Motors Ltd and Mahindra & Mahindra Ltd as comparables for the purpose of computation of royalty ratio. The CIT(A) directed the TPO to adopt Manufacturing sales as denominator while computing royalty ratio both for Comparables and assessee. The TPO had considered Testing expenses characterized as R&D expenses and Technical Assistance fee while computing the Royalty ratio. The CIT(A) has directed the TPO to exclude R&D expenses while computing royalty ratio of the assessee.

7.

Aggrieved by the above order of the CIT(Appeals), the assessee is in appeal before this Tribunal.

8.

Though several grounds are raised, Ground No.1 and 2 are general in nature. Ground No.3 deals with, whether separate benchmarking of royalty can be done. Ground 4 to 9 deals with the ALP computation aspects of Royalty if separate evaluation of Royalty is upheld.

Ground No.3- Separate Benchmarking of Royalty

9.

The assessee had adopted TNMM at the entity level, in which process, the royalty payment is considered as closely linked transaction and part of operating cost in the TP study Report. The Assessee gave detailed reasons as to why royalty is considered as closely linked transaction and should not be separately benchmark before the lower authorities. It is submitted that once the net profit margin is tested on

IT(TP)A Nos.421 & 422, 643 & 644/Bang/2023 Page 5 of 8 the touchstone of arm’s length price, it pre-supposes that the various components of income and expenditure considered in the process of arriving at the net profit are also at arm’s length.

10.

The ld. AR submitted that that the royalty payment of Rs. 374.99 crores is part of ‘other expenses’ in the financial statements. The ‘other expenses’ of Rs. 1158.65 crores are considered as part of operating expenses by the TPO. Thus, it is clear that royalty is included as part of the operating cost while computing the ALP under TNMM. He submitted that this view has been accepted by the Bangalore Tribunal in assessee’s own case for AY 2013-14 [ITA No.2016/Bang/2018, dated 18.08.2021]. Further, the said decision is relied by Bangalore Tribunal in assessee’s own case for AY 2012-13 and AY 2014-15 [IT(TP)A No.150/Bang/2017 & IT(TP)A No.320/Bang/2019 dated 02.12.2022]. Based on the above, the ld. AR for the assessee submitted that the action of the lower authorities of separately benchmarking the royalty payment is bad in law and liable to be quashed. He accordingly submitted that if this issue of separate benchmarking is covered in favour of the assessee, the other grounds No.4 to 9 related to ALP computation of royalty payment becomes academic in nature and may be kept open.

11.

The ld. DR relied on the orders of the lower authorities.

12.

After hearing both the sides, perusing the entire material on record and the orders of the lower authorities, we note that this issue is covered by the decision of the coordinate Bench of this Tribunal in

IT(TP)A Nos.421 & 422, 643 & 644/Bang/2023 Page 6 of 8 assessee’ own case for the for AY 2012-13 & 2014-15 [2023] 147 taxmann.com 558 (Bang.Trib.) where it is held as under:-

“13. We note that assessee's margins have been computed including royalty payment which is higher than the margin of the comparables. It is also not disputed by the revenue that the comparables in case of the comparables, the royalty, margins are computed after including royalty and research and development expenses. The view taken by the Coordinate Bench of this Tribunal in assessee's own case for A.Y. 2007- 08 has been reproduced hereinabove wherein all these aspects have been considered. This Tribunal for A.Y. 2007-08 has deleted the adjustment made by the Ld.TPO in respect of royalty by separately bench marking the transactions. This has been fortified by the clarification given in a Miscellaneous Petition filed by the department which is also reproduced hereinabove. This view is also supported by various decisions of Coordinate Benches of this Tribunal as well as various High courts, Cojoint reading of these orders, we direct the Ld.AO/TPO to delete the adjustment proposed for royalty as a separate international transaction. Respectfully following the above view, we direct the Ld.AO/TPO to delete the adjustment proposed towards royalty as a separate international transaction. Accordingly, ground nos. 10 to 12 raised by assessee stands allowed. 13.1 The ld.DR relied on the order of the lower authorities and he submitted that since the assessee has adopted TNMM and the TPO has also accepted the methods for calculation ALP, the TPO has not made separate adjustment in regard to payment of royalty, therefore, this issue should not be raised by the assessee. 13.2 After hearing both the sides, we observe from the order of the TPO, he has calculated the ALP in regard to royalty payment determined under TNMM of Rs. 154.54 crores however, no separate adjustment of royalty has been proposed by the TPO since the TNMM was adopted at NTT level which includes royalty also. The ld.DRP also expressed his opinion that the TPO has not proposed any adjustment towards royalty payment. Considering the above observations and arguments, we uphold the order of the DRP and no separate adjustment is required for

IT(TP)A Nos.421 & 422, 643 & 644/Bang/2023 Page 7 of 8 the payment of royalty if the TNMM approach has been adopted at entity level as decided by the coordinate bench of the Tribunal in the assessee's own case noted supra, therefore ground Nos.8 to 15 become academic in nature, accordingly, we allow ground nos.8 to 15.” 13. Following the above decision of the coordinate Bench of the Tribunal, we hold that no separate benchmarking of royalty payment is required and this issue is decided in favour of the assessee and ground No.3 is allowed. Thus, grounds no.4 to 9 relating to ALP computation of royalty has become academic and is left open.

14.

Similarly, on the same facts, the ground No.3 raised on this issue for AY 2016-17 is also allowed and thus, ground Nos. 4 to 8 regarding ALP computation of royalty is left open as academic.

15.

Grounds 10 relating to interest u/s 234B is consequential in nature.

Departmental Appeals

16.

The revenue has raised common ground in both the appeals as to whether the CIT(Appeals) was right in holding that testing expenses which have been characterized as R&D expenses do not involve the use of know-how from the AE without verifying the nature of expenses.

17.

We have heard both the parties. Since the assessee’s appeals are allowed holding that that royalty payments should not be benchmarked separately, this issue raised by the revenue relating to ALP

IT(TP)A Nos.421 & 422, 643 & 644/Bang/2023 Page 8 of 8 computation is purely academic and does not require separate adjudication.

18.

In the result, the appeals by the assessee are partly allowed and the appeals by the department are dismissed.

Pronounced in the open court on this 21st day of December, 2023.

Sd/- Sd/- ( GEORGE GEORGE K. ) (LAXMI PRASAD SAHU ) VICE PRESIDENT ACCOUNTANT MEMBER

Bangalore, Dated, the 21st December, 2023. /Desai S Murthy /

Copy to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore.

By order

Assistant Registrar ITAT, Bangalore.

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