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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI BEENA PILLAI & SHRI LAXMI PRASAD SAHU
O R D E R Per Laxmi Prasad Sahu, Accountant Member :-
This is an appeal filed by the assessee against the final Order of Assessment dated 28.01.2022 passed by the DCIT, Circle –2, LTU, Bengaluru (National Faceless Assessment Centre – DIN No.ITBA/AST/S/ 143(3)/2021-22/1039177993(1) ) for the Assessment Year 2017-018 with the following grounds of appeal :- “The grounds mentioned hereinafter are without prejudice to one another. The learned Assessing Officer ('AO') learned Transfer Pricing Officer ('TPO') and the Honourable Dispute Resolution Panel (Hon'ble DRP') grossly erred in determining an adjustment of INR 38,75,40,000/- to the Arm's Length Price ('ALP') of the Appellant's international transactions IT(TP)A No.188/Bang/2022 Page 2 of 9 with its Associated Enterprises (AEs') u/s 92CA of the Income-tax Act, 1961.
The learned AO/ learned TPO/ Hon'ble DRP erred in rejecting the TP documentation maintained by the Appellant by invoking provisions of sub- section (3) of 92C of the Act.
3. The learned AO/ learned TPO/ Hon'ble DRP erred in disregarding the Transactional Net Margin Method (TNMM') search performed by the Appellant to justify the arm's length nature of the royalty transaction.
4. The learned AO/ learned TPO/ Hon'ble DRP erred in not understanding that the Appellant had adopted TNMM for benchmarking the royalty transaction in its TP Documentation of FY 2016-17 as the royalty paid is closely interlinked with the manufacturing operations carried out by the Appellant.
5. The learned AO/ learned TPO/ Hon'ble DRP erred in computing the percentages of purchase and sale to AEs, which has led to incorrect approach for aggregation of transaction.
The learned AO/ learned TPO/ Hon'ble DRP erred in stating that royalty transaction is not linked to the manufacturing activities without appreciating that the Appellant is a licensed manufacturer-and it needs the licensed technology to manufacture its products. Therefore, the royalty transaction is closely linked to the manufacturing activity and hence cannot be evaluated separately. The learned AO/ learned TPO/ Hon'ble DRP erred in adopting the Profit Spilt Method (PSM') for benchmarking the royalty transaction. S. The learned AO/ learned TPO/ Hon'ble DRP erred in concluding that the useful economic life of bundle of technologies transferred to the Appellant has lapsed and royalty paid by the Appellant is for the technical upgrades and the Appellant did not derive any benefit from the technology received from its AEs.
The learned AO/ learned TPO/ Hon'ble DRP erred in their approach by not following the Hon'ble Tribunal's order in the Assessee's own case for previous years wherein TNMM method adopted by the Appellant was upheld. Without prejudice to the above 10. The learned AO/ learned TPO/ Hon'ble DRP has erred in not appreciating the fact that Appellant's Functions, Assets and Risk ('FAR') analysis only revolves around the manufacturing process without any contribution to ownership of unique intangibles, thus leading to incorrect application of PSM. Incorrect application of residual PSM 11. The learned AO/ learned TPO/ Hon'ble DRP erred in benchmarking the royalty payment twice.
The learned AO/ learned TPO/ Hon'ble DRP erred in computing the adjustment towards payment of royalty transaction using residual PSM.
IT(TP)A No.188/Bang/2022 Page 3 of 9 13. The learned AO/ learned TPO/ Hon'ble DRP erred in imposing an adjustment for the royalty transaction using Residual PSM because the Appellant does not make any unique contribution to the licensed technology. The Appellant merely uses the licenses technology to manufacture the products.
The learned AO/ learned TPO/ Hon'ble DRP erred in stating that the Appellant adds significant value to the licensed technology by developing and selling the products. The Appellant merely uses the licensed technology to manufacture auto components and it is no way involved in the development of the licensed technology. The Hon'ble DRP has acknowledged that the AE of the Appellant is responsible for the development and ownership of the licensed technology. Therefore, it is incorrect to conclude that the Appellant is also involved in development and making unique contribution to the licensed technology for which application of Residual PSM is warranted.
The learned AO/ learned TPO/ Hon'ble DRP erred in assigning arbitrary weights to the functions performed by the Appellant vis-à-vis the Associated Enterprises without carrying out a detailed FAR analysis.
16. Further, the learned AO/ learned TPO/ Hon'ble DRP erred in applying a 50:50 profit split without giving any logical reasoning for arriving at this method.
17. The learned AO/ learned TPO/ Hon'ble DRP has also erred in determining the royalty rate at .17% on sales, without giving any logical basis for the same. Corporate tax 18. Interest under section 234B of the Act a) The learned AU erred in levying interest under section 234B of the Act at INR 7,78,58,680/- in the final assessment order. b) In light of the contentions in the aforesaid grounds, the learned AO erred in levying interest under section 234B of the Act in relation to such adjustments. c) Without prejudice to the above, the Appellant submits that interest under section 234B of the Act is consequential in nature. Accordingly, once the abovementioned adjustments are deleted, the interest under section 234B of the Act will get nullified.
19. Penalty proceedings under section 274 read with section 270A of the Act a) The learned AU erred in initiating penalty proceedings under Section 274 read with section 270A of the Act. b) The learned AU failed to appreciate the fact that the Appellant has not furnished any inaccurate particulars of income. The AU failed to appreciate the fact that a mere difference of opinion between the Appellant and the AU would not amount to furnishing of any inaccurate particulars of income.
IT(TP)A No.188/Bang/2022 Page 4 of 9 c) The learned AU failed to appreciate the fact that the additions made by him are on items, which are sub-judice, and hence, no penalty can be levied on such contentious adjustments.”
Ground Nos. 1 to 17 are with regard to determination of ALP of an international transaction between the assessee and its Associate Enterprises (AE) u/s 92 of the Act and also with regard to incorrect application of residual PSM.
The facts in the present asst. year 2017-18 are identical with issue covered by the decision of coordinate bench in the assessee’s own case in IT(TP)A No.1915/Bang/2017 & 337/Bang/2018 vide order dated 18/03/2020 for the assessment year 2013-14 and IT(TP)A No. 1646/Bang/2017 for assessment year : 2013-14 and in IT(TP)A No. 2586/Bang/2019 for the assessment year : 2015-16 vide order dated 13/04/2022 except the figures.
In the aforesaid order, the Tribunal held as follows :-
We have considered the rival submissions. We are of the view that the issue with regard to Most Appropriate Method in the case of assessee had already been settled by the Tribunal. The TPO as well as the DRP have not followed the aforesaid decision of the Tribunal on the ground that economic life of the technology had an impact on the MAM and that technology in question was to be used by start-ups and since the assessee was using the technology for a fairly long period of more than 5 years, it would not be proper to adopt the TNMM as the MAM, as the economic life of the technology would no longer exist. In our view, there is no basis for .be TPO as well as the DRP to come to a conclusion that technology in question was to be used by a start-up. There is no basis for the TPO and DRP to come to a conclusion that the Assessee is a start up in manufacture of various parts for IT(TP)A No.188/Bang/2022 Page 5 of 9 automobiles. The technology in question was that of TMC Japan. The technology is being used by the Assessee even today. There is no basis for the TPO/DRP's conclusion that the useful economic life of the technology would be only 5 years. In any event passage of time cannot be the basis to discard TNMM which is already held by the Tribunal and upheld by the Hon'ble High Court as no longer the MAM because the conditions necessary for PSM as MAM are not met in the case of the Assessee. Even going by Rule 10B(1)(d), there should be contribution by each of the parties to a transaction for earning profits from sale of goods or provision of services. Then the contribution of each of the parties is identified and the profit is split between those parties. In the case of the Assessee the technology is given by TMC, Japan for which royalty is paid. The use of the technology in manufacturing and the sale of the product so manufactured contribute to the profit of the Assessee and TMC, Japan has nothing to do with that. There is therefore absence the first condition for application of PSM as MAM. As submitted by the Assessee PSM is used as MAM only in a case involving transfer of unique intangible or in multiple inter-related international transactions which cannot be valued separately for determining the ALP. The OECD guidelines cited on behalf of the assessee clearly supports the aforesaid approach and the OECD guidelines in this regard reads as follows:- “Further reliance is also placed on OECD Guidelines, which clearly lay down the situations in which the PSM is selected as an appropriate method for benchmarking. The relevant extract from the OECD Guidelines (para 2.109) is as below:
A transactional profit split method may also be found to be the most appropriate method in cases where both parties to a transaction make unique and valuable contributions (e.g. contribute unique intangibles) to the transaction, because in such a case independent parties might wish to share the profits of the transaction in proportion to their respective contributions and a two-sided method might be more appropriate in these circumstances than a one-sided method. In addition, in the presence of unique and valuable contributions, reliable comparables information might be insufficient to apply another method. On the other hand, a transactional profit split method would ordinarily not be used in cases where one party to the transaction performs only simple functions and IT(TP)A No.188/Bang/2022 does not make any significant unique contribution (e.g. contract manufacturing or contract service activities in relevant circumstances), as in such cases a transactional profit split method typically would not be appropriate in view of the functional analysis of that party
The revised guidance (June 2018) on the application of transactional PSM, provided by the OECD state the importance of delineating the transactions in determining whether the PSM is applicable or not. The relevant extract from the OECD Guidelines is provided below:
"2.125. The accurate delineation of the actual transaction will be important in determining whether a transactional profit split is potentially applicable. This process should have regard to the commercial and financial relations between the associated enterprises, including an analysis of what each party to the transaction does, and the context in which the controlled transactions take place. That is, the accurate delineation of a transaction requires a two-sided analysis (or a multi-sided analysis of the contributions of more than two associated enterprises, where necessary) irrespective of which transfer pricing method is ultimately found to be the most appropriate.
2.126. The existence of unique and valuable contributions by each party to the controlled transaction is perhaps the clearest indicator that a transactional profit split may be appropriate. The context of the transaction, including the industry in which it occurs and the factors affecting business performance in that sector can be particularly relevant to evaluating the contributions of the parties and whether such contributions ale unique and valuable. Depending on the facts of the case, other indicators that the transactional profit split may be the most appropriate method could include a high level of integration in the business operations to which the transactions relate and /or the shared assumption of economically significant risks (or the separate assumption of closely related economically significant risks) by the parties to the transactions. It is important to note that the indicators are not mutually exclusive and on the contrary may often be found together in a single case. 2.127. At the other end of the, spectrum, where the accurate delineation of the transaction determines that one party to the transaction performs only simple functions, does not assume economically significant risks in relation to the transaction and does not otherwise make any contribution which is unique and valuable "2.147. Under the transactional profit split method, the relevant profits are to be split between the associated enterprises on an economically valid basis that approximates the divisi6n of profits that would have been anticipated and IT(TP)A No.188/Bang/2022 Page 7 of 9 reflected in an agreement made at arm's length. In general, the determination of the relevant profits to be split and of the profit splitting factors should: Be consistent with the functional analysis of the controlled transaction under review, and in particular reflect the assumption of the economically significant risks by the parties, and Be capable of being measured in a reliable manner."
It is clear from the above OECD guidelines that in 'order to determine the profits to be split, the crux is to understand the functional profile of the entities under consideration. Although the comparability analysis is at the "heart of the application of the arm's length principle", likewise, a functional analysis has always been a cornerstone of the comparability analysis. In the present case the Assessee leverages on the use of technology from the AE and does not contribute any unique intangibles to the transaction. It may be true that the Assessee aggregated payment of royalty with the transaction of manufacturing as it was closely linked and adopted TNMM but that does not mean that the transactions are so interrelated that they cannot be evaluated separately for applying PSM. Further, the Assessee does not make any unique contribution to the transaction, hence PSM in this case cannot be applied.
Therefore, we are of the view that TNMM is the Most Appropriate Method in the case of assessee. The decision of the Tribunal in the earlier AY 2008-09 has also been upheld by the Hon'ble High Court of Karnataka in judgment dated 16.7.2018, which was an appeal of the revenue against the order of Tribunal for AY 2008-09. The Tribunal has upheld TNMM as MAM from AY 2007-08 to 2011-12. In those AYs the dispute was whether TNMM or CUP was the MAM. It is for the first time in AY 2013-14 that the revenue has sought to apply PSM as MAM. In the given facts and circumstances, we are of the view that TNM Method is the Most Appropriate Method and the AO is directed to apply the said method in determining the ALP, after affording opportunity of being heard to the assessee. The grounds of appeal of the assessee are treated as allowed.
The facts in AY 2014-15 are identical and the reasoning given in AY 2013-14 will equally apply to the AY 2014-15 also and the TPO is directed to compute the ALP for AY 2014-15 by applying TNMM as the MAM , after affording due opportunity to the assessee.”
IT(TP)A No.188/Bang/2022 Page 8 of 9 6. Respectfully following the aforesaid decision, we set aside the question of determination of ALP to the TPO afresh applying TNMM as the most appropriate method as was done in Assessment Years 2013-14 and 2014-15 & 2015-16 in the order referred to above. Needless to say the assessee shall be given reasonable opportunity of hearing. Further, the Assessee does not make any unique contribution to the transaction, hence PSM in this case cannot be applied.