TOYOTA KIRLOSKAR MOTOR PVT. LTD. vs. DCIT, BANGALORE

On the basis of various submissions made by assessee, it was held by Ld. TPO that, royalty rate of 5% paid by assessee was disproportionately high and not reasonable. Ld. TPO also observed that, royalty rate varied from 0.82% to 3.25% in case of comparables in automobile industry, as compared to royalty paid by assessee to its AE. Ld. TPO thus considered the royalty rate at 2% to be appropriate and proposed adjustment of Rs.1,07,98,91,825/-. Aggrieved, by proposed adjustments made by Ld. TPO and observation of segregating Trading and Manufacturing transactions which were interlinked with each other, assessee raised objections before DRP. DRP summarily rejected objections of assessee by holding as under. “Objection relating to aggregation vs segmentation: 4.1. The above objection was raised by assessee before DRP during proceedings for a Y 2009-10 as well as 2010-11 and the same were dealt detail Page 11 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 in the orders passed by DRP and none of these objections was accepted. However, in the assessee’s own case for assessment year 2003-04, 2007-08 and 2008-09 issue was decided in favour of assessee by jurisdictional bench of ITAT although with a rider that each year needs to be looked into separately. Further, it is noted from the order of TPO that no adjustment has been determined on the basis of the above segmentation analysis in the year under consideration and as such no prejudice is caused to the assessee. So, the issue is only of academic nature and the year under consideration does not call for any adjudication. So, the same is rejected. Objection relating to royalty adjustment: “5.1. In relation to above objections, detailed submissions have been made by the assessee. The same have duly been considered. However, on examination the order of the TPO it is observed that various objections of the assessee have already been suitably dealt with by the TPO. In assessee’s own case for AY 2007-08, 2008-09 the jurisdiction bench ITAT had directed the TPO to determine the ALP separately in relation to royalty payment. So, there isn’t any infirmity in the order of TPO in this regard. As regards selection rejection of comparables, TPO has given reasons for the same example in case of Ashok Leyland it is not in business of manufacture of passenger car or MUP, Tata motors failed the RPT filter etc. Assessee is objection regarding rejection of multi-year Data has already been dealt elsewhere in this order. Assessee has claimed superior technology but there is nothing to substantiate the said claim. So, no credence can be given to the same. Assessee has claimed that CIT (A) and DRP have accepted both fact as well as quantum of royalty as at arm’s length for the preceding assessment years. However, this claim is also not correct. For AY 2005-06 the CIT (A) had directed TPO to determined ALP of royalty payments asked TPO had failed to do so. For AY 2008-09 and AY 2009- 10 DRP decided in favour of assessee as the TPO had failed to determined ALP of royalty payment in case of assessee as per provisions of the act and simply adopted ALP at nil by holding that assessee had not got any economic benefit by paying the same. Assessee’s claim that royalty paid by it should be treated at arm’s length as the technical assistant agreements were approved by Page 12 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 government authorities also does not carry any weight as approval by the governmental authorities does not prevent TPO from examining the ALP as per the provisions of the act. Considering all these aspects, the objections of assessee cannot be accepted.”

As regards adjustment in respect of advertisements proposed by Ld. TPO, DRP upheld Ld. TPO’s view by holding that assessee has not provided any evidence in support of advertisement expenses and therefore arm’s length price was to be computed at ‘nil’. On receipt of directions from DRP, Ld.AO computed the addition in hands of assessee’s at Rs.1,10,31,43,825/-. Aggrieved by final assessment order passed by Ld.AO, assessee is in appeal before us now. At the outset, Ld. AR submitted that, Ground No.1-3 are general in nature and therefore do not require any adjudication. Ground No.4-10 are in respect of transfer pricing addition made under royalty segment and advertisement segment. Assessee also alleges action of Ld. TPO segregating manufacturing and trading activity.

Ld.AR submitted that, Rule 10A(d) of Income Tax Rules, defines ‘transaction’ as a number of closely linked transactions. He submitted that, by Ld.TPO relied upon decision in case of UCB India (P.) Ltd. v. Asstt. CIT [2009] 121 ITD 131 to hold that trading and manufacturing segment of assessee are distinct. Ld.AR submitted that, Ld. TPO failed to appreciating that both segments are intertwined and inter-related warranting a "combined transaction approach" in arriving at arm's length price. Ld.AR submitted that, assessee had applied TNMM at entity level, since Page 13 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 the transactions between Assessee and its associated enterprises includes purchase as well as sale of parts and components. The transactions are linked and interdependent on each other. He submitted that, various activities are intertwined and inter-related and that part of trading activities are a result of manufacturing activity, that include warrant commitments. He submitted that, international transactions between Assessee and its AE include both service and sale transactions.

Referring to OECD in its Commentary on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Para 1.42 of Guidelines Ld.AR submitted that ideally, in order to arrive at the best approximation of fair market value, arm's length principle should be applied on a transaction by transaction basis ("Separate Transaction" approach). He submitted that, however OECD Guidelines also provide that a "Combined Transaction Approach" can be adopted in case transactions are closed linked or continuous and they cannot be evaluated adequately on an individual basis. It has been submitted by Ld.AR that, in such a situation, rather than assessing arm's length price of transactions individually, these transactions could be evaluated together using the most appropriate method. The relevant observations relied by Ld.AR are extracted herein below: "However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include 1. some long-term contracts for the supply of commodities or services, 2. rights to use intangible property, and 3. pricing a range of closely-linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or Page 14 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 transaction. Another example would be the licensing or manufacturing know-how and the supply or vital components to an associated manufacturer,' it may be more reasonable to assess the arm's length terms {or the two items together rather than individually. Such transactions should be evaluated together using the most appropriate arm's length method or methods". (Emphasis supplied) 10. He submitted that, decisions relied upon by Ld. TPO in case of UCB India (P.) Ltd. (supra) are applicable only when activities clubbed are dissimilar or are not closely linked, which is not the case of assessee. On the other hand, Ld. DR relied upon orders passed by authorities below. We have perused submissions advanced by both sides in light of records placed before us.

Admittedly Ld.TPO has not made any adjustment upon segregating trading and manufacturing segment. However, Ld. AR vehemently submitted that, the two segments cannot be segregated, as they are interlinked and intertwined with each other and that assessee has determined the ALP by using TNMM at entity level. It is observed that, this issue has been considered by this Tribunal in assessee’s own case for AY 2003-04, 2007-08, 2008-09 and 2010-11. In IT(TP)A No.6&108/Bang/2018 vide order dated 30/06/2016 in assessee’s own case, this Tribunal observed that, Ld.TPO for AY 2012-13 accepted manufacturing and trading segment as integrated and combined transaction for purpose of determining ALP under TNMM. Further, it has also been recorded therein that for assessment year 2007-08, decision of this Tribunal Page 15 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 in assessee’s own case reported in [2014] 48 taxmann.com 380 (Bangalore - Trib.) has concluded in para 46 as under:

Revenue has not been able to establish any factual differences between the year under consideration as well as preceding Assessment and successive assessment year. More over Revenue has accepted combined transaction approach of Trading and Manufacturing segment in immediate subsequent assessment year. We therefore do not find any reason to deviate from the same. Further Ld. TPO has held Trading and Manufacturing segments independently to be at arm’s length. On the basis of above discussions, respectfully following earlier orders of this Tribunal, we direct Ld.AO/TPO to compute ALP by considering trading and manufacturing segments as interlinked with each other and as a combined transaction.

In respect of addition made to royalty, it is observed that, this transaction was also considered to be interlinked with trading and manufacturing segment. However, Ld.AR do not object to it being considered separately in view of observations by this Tribunal in assessee’s own case in preceding assessment years Page 16 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 (supra). The Ld. AR submitted that, in preceding assessment years, Ld.TPO considered ALP of transaction to be at ‘nil’, whereas there is a slight departure in the method of computing ALP, for year under consideration. He submitted that, during the year under consideration, Ld.TPO on an ad hoc basis computed adjustment in respect of royalty paid by assessee to its AE at 2%.

He submitted that, on the basis of comparables which was submitted before Ld.TPO and accepted order u/s 92 CA, payment made by assessee to its AE is at arm’s length independently. He submitted that, average margin of comparables referred to in Ld.TPO’s order is 1.92% whereas assessee has paid Royalty at 5%. It was submitted that, as assessee’s margin is more than comparables the transaction is at arm’s length. He also submitted that, there is no basis on which learnt TPO computed adjustment to royalty at 2%.

On the contrary Ld.CIT DR submitted that, issue may be set aside to learnt AO/TPO for determined in the arm’s length price of the transaction in accordance with law as has been held by this Tribunal in assessee’s own case in preceding assessment years (supra). We have perused submissions advanced by both sides in light of records placed before.

Assessee in transfer pricing study considered royalty as a part of operating expenses in TNMM as most appropriate method. The Ld.AR referring to page 981 of paper book, submitted that comparison of percentage of average royalty in respect of comparables was submitted which comes to 3% and 2.27%. Whereas assessee has paid royalty to its AE at 5%. He submitted Page 17 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 that, since average percentage of royalty expenditure on net sales of assessee is much lower than percentage of royalty and R&D expenditure on net sales of proposed comparables, the transaction of royalty payments to AE has to be treated at arm’s length. It is also been submitted that, most of the auto parts companies are paying royalty of 3% to 5% and assessee is being royalty at 3% on part sales. He thus submitted that, even if royalty is to be considered independently, the transaction is at arm’s length as compared to the comparables considered by Ld.TPO. We agree with the submissions made by Ld. AR insofar as considering the margin of transaction computed by assessee vis-a-vis average margin of comparables. However, in our view this needs to be verified by Ld. AO/TPO.

We, therefore, direct Ld.AO/TPO to consider the above submissions of assessee and to recompute ALP of the transaction, in accordance with law. It is also directed that, comparables considered by Ld.TPO in the order passed under section 92CA of the Act, should be considered for computing ALP of the transaction. Accordingly, we set aside this issue back to Ld. AO/TPO with the aforestated directions.

As regards the adjustment made towards the claim of expenditure, Ld. AR submitted that, assessee is in a position to file all the relevant details which could be verified by Ld.AO/TPO. Ld. CIT DR did not object to the submissions of assessee.

Considering the submissions made by both sides, we are of the opinion that Ld. AO/TPO shall verify the details filed by assessee and to compute ALP of transaction by using most Page 18 of 18 IT(TP) 256/Bang/2016 A. Y : 2011 – 12 appropriate method, that would be applicable in accordance with law. Needless to say, that assessee shall be granted proper opportunity of being represented. Accordingly, these grounds raised by assessee stands allowed for statistical purposes. Ground No.11 is general in nature and therefore do not require any adjudication. Ground No.12 has not been argued by Ld.AR and hence accordingly not adjudicated. Ground No.13 is consequential in nature. In the result, appeal filed by assessee stands partly allowed for statistical purposes. Order pronounced in the open court on 6th March, 2020.