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Income Tax Appellate Tribunal, DELHI BENCH ‘I-1’ : NEW DELHI
Before: HON’BLE, SHRI N.K. SAINI & SHRI KULDIP SINGH
PER KULDIP SINGH, JUDICIAL MEMBER :
The Appellant, M/s. Nissin Brake India Pvt. Ltd. (hereinafter referred to as ‘the taxpayer’) by filing the present appeal sought to set aside the impugned order dated 07.09.2017 passed by the AO in consonance with the orders passed by the ld. DRP/TPO under section 143 (3) read with section 144C of the Income-tax Act, 1961 (for short ‘the Act’) qua the assessment year 2013-14 on the grounds inter alia that :-
“1. That on the facts and circumstances of the case and in law, the AO has erred in assessing the total income of the Appellant for the relevant AY at Rs.67,686,945 as against the returned income of NIL (considering brought forward losses).
2. That on the facts and circumstances of the case and in law, the Hon'ble Dispute Resolution Panel ("DRP") / AO / Transfer Pricing Officer ("TPO") erred in making a transfer pricing adjustment of Rs.67,686,945 in respect of the international transactions relating to the payment of royalty and product development service fees paid by the Appellant to its Associated Enterprise CAE").
3. That on the facts and circumstances of the case and in law, the DRP / AO / TPO while rejecting Appellant's determination of arm's length price for its international transactions have resorted to cherry picking and erred in including inappropriate comparable which is functionally not comparable to the Appellant
4. That on the facts and circumstances of the case and in law, the DRP / AO / TPO have erred in arbitrarily rejecting certain functionally comparable companies identified by the Appellant.
5. That on the facts and circumstances of the case and in law, the DRP / AO / TPO have erred in rejecting without providing any reason, the capacity utilization adjustment conducted by the Appellant in its transfer pricing documentation without taking cognizance of the fact that the Appellant was operating at different level of capacity, i.e. unabsorbed fixed cost to sales as compared to comparables and hence, erred in denying the economic adjustment for the difference in capacity levels of the Appellant vis-a-vis comparables and disregarding their own approach for AY 2009-10 and AY 2010-11 where capacity utilization adjustment has been granted to the Appellant.
6. The learned DRP/AO/TPO erred on facts and in law in:
6.1. determining that the Appellant is not getting any benefit from the payment of royalty and product development services fees and determined the arm's length value of such transactions to be NIL.
6.2. concluding that the Appellant has not bench marked the transactions pertaining to the payment of royalty and product development service fee undertaken by the Appellant with its AE by applying the most appropriate method. 6.3. pronouncing any verdict on the payment of royalty. 6.4. disregarding their own approach in the case of the Appellant for AY 2009-10, AY 2010-11 and AY 2012-13, wherein the similar approach adopted by the Appellant was accepted, i.e. TNMM as the most appropriate method for benchmarking the international transaction in relation to payment of royalty and product development service fees.
7. That on the facts and circumstances of the case and in law the Ld. AO erred in initiating penalty proceedings u/s 271(1)(c) of the Act.
8. That on the facts and circumstances of the case and in law, the Ld. AO erred in proposing to charge interest under section 234B and 234C of the Act.”
Briefly stated the facts necessary for adjudication of the controversy at hand are : M/s. Nissin Brake India Pvt. Ltd., the taxpayer is into manufacturing, altering, procurement, sale and trading of all types of auto motive and aluminum and/or non- automotive brake and aluminum components, spare parts and other related accessories having manufacturing plant in Neemrana, Rajasthan. Nissin Kogyo Co. Ltd., Japan (Parent company) is into developing and manufacturing a wide range of brake products for motorcycles and four-wheeled vehicles. The taxpayer entered into international transactions with its Associated Enterprises (AEs) during the year under assessment as under :-
Type of International Method Nissin India (Tested Compar- transaction Selected Party) ables Total Value of Price/ Arithmetic Transaction Margin Mean Price/ Margin Purchase of traded goods TNMM 160,175,793 13.8% 7.77% using OP/ OR as PLI Purchase of raw material 417,712,581 consumables & consumable tools TNMM using Purchase of capital goods 113,015,356* OP/OR as Payment of royalty 16,931,154 PLI Receipt of technical services 13,718,595 0.65% -3.16% Sale of goods 725,136 Receipt of product 50,755,791 development services Reimbursement of expenses 26,943,379 paid/ payable Trade Payables 217,576,553 Trade receivables 326,575 Credit guarantee Other Nil NA Method *The fees paid for technical services includes INR 8,846,900 which has been capitalized during the FY 2012-13.
During the year under assessment, the taxpayer was engaged in trading, sales and manufacturing of brake and brake products and in order to benchmark its international transactions, the taxpayer selected 7 companies as comparable. The taxpayer claimed capacity adjustment in the transfer pricing study qua its manufacturing segment and shown the margin earned by it vis-à- vis comparable as under :-
Segment Nissin India Comparable companies Trading 13.28% 7.77% 4.01% (unadjusted) Manufacturing 0.65% (-) 3.16% (adjusted)
Out of 7 comparable companies chosen by the taxpayer, TPO rejected 3 comparables, conducted a fresh search of the companies engaged in manufacturing of different products, included one additional comparable and computed 4.36% as margin as the benchmark for making addition on the cost base of the taxpayer amounting to Rs.4,46,91,884/- and thereby made an adjustment of Rs.8,14,05,540/- on account of royalty paid, fee for technical support services and product development services primarily on the ground that the taxpayer is not drawing any benefits from the above services.
The taxpayer carried the matter before the ld. DRP by filing objections who has disposed of the objections. Feeling aggrieved, the taxpayer has come up before the Tribunal by way of filing the present appeal.
We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case.
GROUND NO.1
Ground No.1 is general in nature and does not require any adjudication.
GROUND NO.2 & 6
Undisputedly, the taxpayer has paid an amount of Rs.8,14,05,540/- on account of fee for receipt of technical support services and royalty. It is also not in dispute that the assessee has paid royalty to Nissin Kogyo, its AE @ 3% of the value added on the product and parts manufactured and/or procured and sold by it.
It is also not in dispute that taxpayer has entered into agreement with Nissin Kogyo for grant of right to use the trademarks and to manufacture products under Intellectual Copyright (IPR) and by using technical information provided by Nissin Kogyo on the payment of royalty @ 3% of the value added. It is also not in dispute that the TPO has rejected TNMM as the Most Appropriate Method (MAM) to benchmark its international transactions qua payment of royalty and applied CUP method. It is also not in dispute that fee for technical services has been allowed but payment of royalty and product development fee has been disallowed.
Ld. TPO declining the contentions raised by the taxpayer that similar royalty payment has been made by the other group entities to Nissin Kogyo and brought on record evidence by way of supplementary analysis, available at pages 327 to 333 of the paper book, termed the royalty payment as common/duplicate in nature on the grounds inter alia that :-
(a) The assessee has not answered whether similarly royalty is being paid by other worldwide entities to the same AE with evidence thereof; (b) The assessee has not explained the benefits that the assessee has availed on account of this royalty pay out with evidence; and (c) The assessee has not explained how royalty payment has helped the assessee in improving its manufacturing process with evidence. 10. However, we are of the considered view that when the taxpayer has come up with supplementary analysis for payment of royalty showing the royalty paid by the taxpayer vis-à-vis independent third party for use of similar intangibles, the royalty charge between third party licensor and licensee generate an average royalty of 7.20% of the sales, this issue is required to be examined in detail. Moreover, royalty at the same rate of 3% has been paid by other group entities to Nissin Kogyo through invoices and agreement brought on record during TP proceedings.
Moreover, the TPO has rejected the TNMM as MAM used by the assessee and applied CUP and determined the ALP of payment tor royalty and technical support fee at nil on the ground that no independent person in similar circumstances would pay any such royalty and fee for technical services. So, the TPO has applied the benefit test by observing that the taxpayer has failed to furnish certain vital information like; as to what cost benefit analysis was done; what is the royalty rate paid by other AEs or independent persons; what is the industry rate; what is the cost incurred by the AE for developing the intangibles; what was the expected benefit from the use of the intangibles etc. But these observations appear to be not correct as the taxpayer has brought on record the supplementary analysis comparing the payment of royalty paid by the taxpayer vis-à-vis 2 independent third parties for similar intangibles and also brought on record the fact that in similar arrangement, average royalty is 7.20% of the sales.
The ld. AR for the taxpayer drew our attention to the Agreement, available at page 352 of the paper book, entered into between unrelated parties for similar products and also for same amount of royalty. It is further contended by the ld. AR that similar agreements along with supporting evidences were furnished for payment of royalty by other AEs (Shandong Nissin Industry Co. Ltd., China and Nissin Brake Philippines Co. Ltd.) at similar rate of 3%.
So far as question of payment of product development fee is concerned, taxpayer stated to have availed product development services from Nissin Kogyo on payment of fee as it does not have any research and development centre in India. The taxpayer filed plethora of documentary evidence to prove the product development fee viz. agreement, available at pages 963 to 966 of the paper book, invoice issued by Nissin Kogyo to the taxpayer, available at pages 1216 to 1217 of the paper book, evidence for product development fee by other AE to Nissin Kogyo, available at page 967 of the paper book, product-wise working explaining the impact of the product development services provided by the AE on the sales of product manufactured by the assessee, available at pages 969 of the paper book and request received from customers via email to modify the products.
The ld. AR for the taxpayer in support of his contentions relied upon the decision of Hon’ble Delhi High Court in CIT vs. EKL Appliances Ltd. – 341 ITR 241 (Del.) and also relied upon the decisions of DCIT vs. Air Liquid Engineering India Pvt. Ltd. – Thyseenkrupp Industries India Pvt. Ltd. – ITA No.7032/Mum/2011 and Toyota Kirloskar Auto Parts Pvt. Ltd. vs. ACIT – IT(TP)A.No.1642/Bang/2012.
However, on the other hand, ld. DR for the Revenue contended that for determining the ALP of royalty and product development fee, best method is the CUP and not TNMM and relied upon the orders passed by the ld. TPO/DRP/AO.
Hon’ble Delhi High Court in case of CIT vs. EKL Appliances Ltd. (supra) has decided the issue as to payment of royalty and held that it is mandatory for the TPO to work out the relevant transactions by applying some authorized method and the entire cost borne by the taxpayer cannot be disallowed by taking the ALP at nil. Operative part of the judgment (supra) is reproduced as under :-
“19. There is no reason why the OECD guidelines should not be taken as a valid input in the present case in judging the action of the TPO. In fact, the CIT (Appeals) has referred to and applied them and his decision has been affirmed by the Tribunal. These guidelines, in a different form, have been recognized in the tax jurisprudence of our country earlier. It has been held by our courts that it is not for the revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur. We may refer to a few of these authorities to elucidate the point. In Eastern Investment Ltd. v. CIT, (1951) 20 ITR 1, it was held by the Supreme Court that “there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of the Income Tax Act”. It was further held in this case that “it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned”. In CIT v. Walchand & Co. etc., (1967) 65 ITR 381, it was held by the Supreme Court that in applying the test of commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. It was further observed that the rule that expenditure can only be justified if there is corresponding increase in the profits was erroneous. It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand, (1938) 6 ITR 636 that “expenditure in the course of the trade which is unremunerative is none the less a proper deduction if wholly and exclusively made for the purposes of trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense”. The question whether an expenditure can be allowed as a deduction only if it has resulted in any income or profits came to be considered by the Supreme Court again in CIT v. Rajendra Prasad Moody, (1978) 115 ITR 519, and it was observed as under: -
“We fail to appreciate how expenditure which is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by way of expenditure must be debited irrespective of whether there is receipt of income or not. That is the plain requirement of proper accounting and the interpretation of Section 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income.”
It is noteworthy that the above observations were made in the context of Section 57(iii) of the Act where the language is somewhat narrower than the language employed in Section 37(1) of the Act. This fact is recognised in the judgment itself. The fact that the language employed in Section 37(1) of the Act is broader than Section 57(iii) of the Act makes the position stronger.
In the case of Sassoon J. David & Co. Pvt. Ltd. v. CIT, (1979) 118 ITR 261 (SC), the Supreme Court referred to the legislative history and noted that when the Income Tax Bill of 1961 was introduced, Section 37(1) required that the expenditure should have been incurred “wholly, necessarily and exclusively” for the purposes of business in order to merit deduction. Pursuant to public protest, the word “necessarily” was omitted from the section.
21. The position emerging from the above decisions is that it is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred “wholly and exclusively” for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above.
22. Even Rule 10B(1)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was unremunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/ brand fee, because it has been suffering losses continuously. So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised.”
So, applying the law laid down by the Hon’ble Delhi High Court in CIT vs. EKL Appliances Ltd. (supra) and the fact that the Revenue has been applying TNMM approach on year to year basis in case of the taxpayer but, during the year under assessment, the TPO has abruptly applied the CUP method without assigning any reason, and the TPO has decided the issue by sitting on the arm- chair of the businessman/taxpayer by applying the benefit test which is not permissible, and the fact that payment of royalty and product development fee are intrinsically interlinked with the productions and sales and can only be decided under TNMM, this issue is required to be set aside to the TPO to decide afresh after providing an opportunity of being heard to the taxpayer. So Grounds No.2 & 6 are allowed for statistical purposes.
GROUNDS NO.3 & 4 18. The taxpayer has also challenged the inclusion of Munjal Showa Ltd. and exclusion of Bosch Chasis Systems India Ltd. as comparable for benchmarking the international transactions. We would examine the suitability of Munjal Showa Ltd. and Bosch Chasis Systems India Ltd. as comparable vis-à-vis the taxpayer one by one.
MUNJAL SHOWA LTD.
The Taxpayer has challenged in the inclusion of Munjal Showa Ltd. on the grounds inter alia that it is engaged in manufacturing of different products vis-à-vis the products manufactured by the taxpayer; that the turnover of the Munjal Showa Ltd. is 10 times bigger than the taxpayer; that Munjal Showa Ltd. engaged in different manufacturing activities viz. shock absorber as compared to the taxpayer; and relied upon the decision of PMC – Sierra India Pvt. Ltd. – (TS-681-ITAT-2016 (Bang.)-TP); Swiss Re Global Business Solutions India Pvt. Ltd. (TS-307-ITAT-207 (Bang)-TP) and ACIT vs. McAfee Software (India) Pvt. Ltd. (IT(TP)A.No.1388/Bang/2011 and IT (TP)A.No. 04/Bang/2012- AY 2005-06.
20. However, on the other hand, ld. DR contended that Munjal Showa Ltd. is a valid comparable and relied upon the order passed by the TPO.
However, the TPO retained this comparable on the ground that it is engaged into manufacturing of auto parts. But it is admitted fact on the file that the taxpayer has not contested this comparable before TPO by filing TP study. When we examine the order passed by DRP though it is discussed in para 4.1.3 of the order that the assessee is in initial year of production so its base and scale of operation is quite low whereas the comparable companies selected in the transfer pricing study in relation to the manufacturing segment are into manufacturing of auto components for years ranging from 31 years to 51 years and discussed the same in tabulated form but retained the Munjal Showa Ltd. as a valid comparable.
Even during the course of arguments before the Tribunal, the taxpayer has not come up with financials of Munjal Showa Ltd. In the given circumstances, we deem it fit to remand this issue to ld. TPO to decide afresh in view of the decision relied upon by the taxpayer after providing an opportunity of being heard to the taxpayer.
Bosch Chasis Systems India Ltd. is taxpayer’s own comparable rejected by the ld. TPO on the sole ground that it is having different financial year. There is no dispute as to the functional similarity of Bosch Chasis Systems India Ltd. vis-à-vis the taxpayer. It is the settled principle of law laid down by Hon’ble Delhi High Court in Mckinsey Knowledge Centre case that a comparable cannot be rejected merely on the ground of having different financial year in case annual result can be reasonably extrapolated. Moreover, the ld. TPO was empowered enough to call for the complete data u/s 133 of the Act to reach at the logical conclusion. So, in these circumstances, we remand this issue to the TPO directing him to decide afresh to determine the suitability of Bosch Chasis Systems India Ltd. as a comparable after providing an opportunity of being heard to the taxpayer.
Grounds No.3 & 4 are allowed for statistical purposes.
GROUND NO.5
TPO/DRP/AO have denied the capacity utilization adjustment claimed by the taxpayer in its transfer pricing study. The taxpayer claimed transfer pricing adjustment on the grounds inter alia that the taxpayer is operating at different level of capacity i.e. unabsorbed fixed costs to sales as compared to vis-à-vis comparable companies; that the taxpayer commenced its commercial production in October 2008 whereas comparable companies have been in business of manufacturing of auto components from 17 years to 51 years as tabulated in para 4.1.3 of the DRP; and that scale of operation of the taxpayer is also very low.
The ld. AR for the taxpayer contended that the issue as to grant the capacity utilization adjustment was decided by the coordinate Bench of the Tribunal in taxpayer’s own case in AY 2010-11 vide order dated 22.09.2017, copy available at pages 285 to 294 of the paper book, which was further followed by the Revenue in AY 2012-13. When the taxpayer is working on the same business model during the year under assessment, there is no reason to violate the settled rule of consistency.
The ld. DR for the Revenue by relying upon the order passed by ld. TPO/DRP contended that merely on the basis of the fact that the taxpayer is a new company and the comparable companies are old one, capacity utilization cannot be granted because sometimes new company may utilize its 100% capacity whereas old one may utilize its 50% capacity. However, when we examine page 10 of the order passed by the TPO no reason whatsoever has been assigned to deny the claim of “capacity utilization adjustment” rather rejected the claim of the taxpayer by recording one sentence i.e. “therefore, the claim of the assessee for capacity utilization is being rejected.” At the same time, when we examine the order passed by the ld. DRP at pages 14 & 15 of the order, it is recorded that complete data for claiming capacity utilization adjustment by the taxpayer has not been brought on record, so in these circumstances, we have no option except to remand this issue back to the TPO to decide afresh on providing complete data by its taxpayer to substantiate the claim for capacity utilization adjustment and after providing an opportunity of being heard to the taxpayer.
GROUND NO.7 27. Ground No.7 being premature needs no specific findings.
GROUND NO.8
Ground No.8 being consequential in nature needs no specific findings.
Resultantly, the appeal filed by the taxpayer is allowed for statistical purposes. Order pronounced in open court on this 16th day of November, 2018.