M/S. CHEMETALL RAI INDIA LTD.,,PUNE vs. DEPUTY COMMISSIONER OF INCOME-TAX,,

आदेश / ORDER PER R.S.SYAL, VP :

This appeal by the assessee is directed against the order passed by the CIT(A) on 18-07-2016 in relation to the assessment year 2009-10.

2 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

on intangible asset, namely, exclusive rights granted by means of a

license to the assessee by its Associated Enterprise (AE) under the

Technology License Agreement for manufacture and sale of new

line of products in India.

its return declaring total income of Rs.9.87 crore and odd. Certain

international transactions were reported in Form No. 3CEB. The

Assessing Officer (AO) made a reference to the Transfer Pricing

Officer (TPO) for determining the Arm’s Length Price (ALP) of

the international transactions. One of the reported international

transactions was `Payment for technical know-how fees’

amounting to Rs.7,27,85,160/-. The assessee applied the

Transactional Net Margin Method (TNMM) as the most

appropriate method for demonstrating that the first six transactions,

including the instant transaction, were at ALP. The assessee

selected certain comparables, whose average Profit Level Indicator

(PLI) was worked out at 7.01% as against its own PLI of 16.27%.

That is how, the assessee claimed the international transaction of

`Payment of technical know-how fees’ at ALP. During the course

of proceedings before the TPO, the assessee stated that it entered

into an agreement with Chemetall Corporation, USA and got

3 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

exclusive rights to use technical know-how, information,

documentation including trademark use, customers’ lists and

agreements to manufacture and distribute the new products viz.,

MPP products, namely, Paint detack, Industrial booth ultrasonic

cleaners and Paint booth sludge handling chemicals in India. The

assessee further submitted that Chemetall Oakite Inc. USA

(subsidiary of Chemetall GmbH subsequently named as Chemetall

Inc.) acquired intangibles, viz., goodwill and customer list of MPP

products from an uncontrolled independent third party, namely, GE

India Industrial P. Ltd., for 1.79 million US dollars, which, in turn,

were transferred to the assessee for 1.428 million US dollars, that

translated into payment of Rs.7.27 crore and odd by the assessee to

its AE. The TPO observed that the assessee paid a lump sum

royalty for technical know-how of Rs.7.27 crore as per Technology

License Agreement dated 31-03-2009 which was, in fact, signed on

21-04-2009. The TPO further noticed that the assessee was to pay

regular royalty @ 5% of net sales from 01-04-2009 in addition to

the lump sum royalty of Rs.7.27 crore. He noticed that the assessee

was paying product royalty prior to the above agreement to M/s.

Hebro Chemie GmbH as per an agreement dated 16-06-2005. He

thus held that the assessee was not in a position to demonstrate as

to how technical know-how was acquired and used for production.

4 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

This led to the determination of Nil ALP of this transaction, which

resulting into the recommendation of Transfer Pricing adjustment

of equal amount at Rs.7,27,85,160/-. The AO in his final order

dated 25-04-2013 made the above Transfer pricing addition. The

assessee challenged the final assessment order before the ld.

CIT(A) and furnished certain further details. The ld. CIT(A)

forwarded such details to the AO for comments. The TPO vide his

first remand report dated 12-08-2015 reiterated his earlier view.

Subsequently, another remand report of the TPO dated 05-04-2016

was also submitted, in which he observed that the assessee vide

agreement dated 31-03-2009 purchased these rights for 302

existing products and 10 future products for a consideration of

1.428 million dollars as against Chemetall Corporation acquiring

such rights from a third party on 31-12-2007 for a consideration of

1.816203 million dollars. Since Chemetall Corporation, USA

acquired these rights in an earlier year and transferred the same to

the assessee on 31-03-2009, the TPO depreciated the cost of

acquisition in the hands of Chemetall Corporation, USA and thus

found out the depreciated value as on 31-03-2009 at Rs.1.191883

million dollars or Rs.6,07,50,277/-. He re-computed the ALP at

this level and proposed the Transfer Pricing adjustment of

Rs.1,20,34,883/- (Rs.7,27,85,160/- minus Rs.6,07,50,277/-) .

5 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

of the authorities below and the details furnished by the assessee

came to hold that the view point of the TPO/AO in proposing/

making the transfer pricing adjustment/addition for a total payment

of Rs.7.27 crore was not warranted in as much as the assessee

capitalized such amount and simply claimed depreciation on it for

a sum of Rs.92,33,569/-, which was also separately added back by

the AO in the final assessment order. Ergo, he concurred with the

action of the AO in disallowing the depreciation claim amounting

to Rs.92.33 lakhs on the ground that the relevant agreement was

executed on 21-04-2009, i.e. after the end of the financial year

relevant to the assessment year under consideration and the

assessee did not acquire any legal or constructive rights over

technical know-how during the year under consideration. The

assessee has come up in appeal before the Tribunal against such a

view canvassed in the first appeal.

material on record. It is an undisputed position that the assessee

paid a sum of Rs.7.27 crore during the year to its Associated

Enterprise, namely, Chemetall Corporation, USA for acquiring

exclusive rights to use technical know-how etc. for manufacturing

6 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

and distributing the MPP products. The assessee capitalized such

amount in its books of account and claimed depreciation for the

year at a sum of Rs.92.33 lakhs. The AO not only disallowed the

amount of depreciation but also made transfer pricing addition

equal to the sum paid by the assessee on the basis of the TPO’s

original recommendation. The ld. CIT(A) has deleted the transfer

pricing addition of Rs.7.27 crore while sustaining the depreciation

disallowance. No cross appeal having been filed by the Department

has been brought to our notice. Thus, it becomes overt that the

Revenue has accepted the deletion of addition of Rs.7.27 crore by

the ld. CIT(A).

deleting such an addition is valid as per law because the assessee

capitalized such payment of Rs.7.27 crore for acquiring technical

know-how and claimed depreciation of Rs.92.33 lakh on such an

amount. Section 92(1) of the Income-tax Act, 1961 (hereinafter

also called `the Act’) clearly provides that ‘any income arising

from international transaction shall be computed having regard to

the arm’s length price’. This provision mandates that it is only the

ALP of the income arising from the international transaction which

is taken into consideration for computing the total income. If there

7 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

is an international transaction which has not resulted into any

deduction/income for its full value, then the transfer pricing

addition, by calculating the ALP of the international transaction,

can be made only with reference to that part of the value of

international transaction for which income/expenditure has been

recognized. For example, if an assessee purchases a capital asset

from its AE for a sum of Rs.100/-, which is capitalized and no

depreciation is claimed thereon, the ALP of the purchase of asset

even if it is found to be at Rs.90/-, would not lead to any TP

adjustment of Rs.10/- (Rs.100 – Rs.90) in the year of its purchase

because the assessee did not claim any deduction on account of

such international transaction. It will simply reduce the ALP of the

purchase of asset at Rs.90/- which will be relevant in subsequent

years for the purpose of granting depreciation allowance. If, on the

other hand, in the above example, the assessee has claimed

depreciation in the year of purchase of the asset at, say Rs.10/-, it

will be the amount of depreciation which would undergo change

by Re.1/- (Rs.10, being depreciation on the purchase price of asset

of Rs.100 minus Rs.9/-, being depreciation on the ALP of the

international transaction of purchase price at Rs.90), due to the

transfer pricing addition w.r.t. the ALP of the purchase price of

asset.

8 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

assessee paid Rs.7.27 crore as technical know-how fee to its AE,

and capitalized the same in its books of account without claiming

the same as a revenue expenditure. In such a scenario, no exception

can be taken to the view of the ld. CIT(A) in deleting the transfer

pricing addition of Rs.7.27 crore which was not claimed as

deduction by the assessee for the purposes of computing income

during the year under consideration except for depreciation.

assessee paid Rs.7.27 crore and the TPO in the revised remand

report has determined the ALP of the international transaction of

purchase of technical know-how at Rs.6.07 crore, leading to the

transfer pricing adjustment of Rs.1.20 crore, which stands

superimposed on the original Nil ALP of the international

transaction. Once, there is a positive ALP of the international

transaction of purchase of asset, ordinarily, depreciation should

have been allowed w.r.t. such ALP of Rs.6.07 crore. The ld.

CIT(A) has chosen to disallow the full amount of depreciation on

the ground that the Agreement with the AE was entered into by the

assessee on 21-04-2009, i.e. after the close of the year albeit it was

effective from 31-03-2009. The ld. first appellate authority opined

9 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

that since no asset was acquired and such technical know-how was

not used during the year, there could have been no claim of

depreciation on such amount.

correct ALP of the international transaction of `Payment of

technical know-how’ fee paid by the assessee at Rs.7.27 crore. The

TPO, in the remand proceedings, found that the assessee’s AE

purchased the same know-how from G E India for a sum of

$1.8162 and sold it to the assessee on 31.3.2009 for a sum of

$1.428 (equivalent to Rs.7.27 crore). The assessee urged to the

TPO in such remand proceedings that it was an internal

comparable, which ought to have been taken into account for

determining the ALP of the international transaction of payment of

technical know-how fee under the Comparable Uncontrolled Price

(CUP) method. The TPO accepted such a contention and applied

the CUP method by taking the comparable uncontrolled price on

31.12.2007 at $1.816203. After adjusting it with the amount of

depreciation for the intervening period, he determined the ALP of

purchase of technical know-how by the assessee at $1.191883

(equivalent to Rs.6.07 crore). The ld. AR challenged the

determination of the ALP in the above manner.

10 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

assessee itself offered the CUP method and the comparable

uncontrolled transaction of sale of the technical know-how by G E

India to its AE in 2007. It is manifest that even under the CUP

method, some adjustments are warranted in the price of the

uncontrolled transaction to bring the same at par with the

international transaction. Rule 10B(1)(a) of the Income-tax Rules,

1962, dealing with the determination of the ALP under the CUP

method, provides as under : -

(a) comparable uncontrolled price method, by which,—

(i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified ;

(ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market ; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm’s length price in respect of the property transferred or services provided in the international transaction ;

10B(1)(a) that the price of the property transferred in a comparable

uncontrolled transaction is required to be adjusted to account for

differences between the international transaction and the

11 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

comparable uncontrolled transactions. Rule 10B(4), which is

relevant for our purpose, unequivocally provides as under :-

The data to be used in analysing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to the financial year in which the international transaction has been entered into : Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.

data to be used in analysing the comparability of an uncontrolled

transaction with an international transaction shall be the data

relating to the financial year in which the international transaction

has been entered into. However the proviso to such rule stipulates

that data relating to a period not being more than two years prior

to such financial year may also be considered if such data reveals

facts which could have an influence on the determination of

transfer price in relation to the transaction being compared.

assessee itself proposed the comparable uncontrolled transaction of

sale of the same technical know-how by GE India to the assessee’s

AE. Thus, there can be no dispute on the selection of the

12 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

comparable uncontrolled transaction. Further, the assessee

proposed the CUP method, which has been accepted by the TPO in

the second remand proceedings. Once there is an admitted

comparable uncontrolled transaction, which has to be taken for

determining the ALP of the international transaction, then it is but

natural that the effect of differences between the comparable

uncontrolled transaction and the international transaction, if any,

should be adjusted. In the extant case, there is a time gap of less

than two years between the comparable uncontrolled transaction

and the international transaction. When we read rule 10B(1)(a)(ii)

and (iii) in conjunction with rule 10B(4), it becomes clear beyond

any shadow of doubt that no exception can be taken to the

determination of the ALP of the international transaction at Rs.6.04

crore, as the same represents the comparable uncontrolled price of

$1.816203 as on 31.12.2007, which has been adjusted to

$1.191883 under the provisions of rule 10B to bring it at par with

the international transaction taking place later on. We, therefore,

uphold the determination of the ALP of the international

transaction of purchase of technical know-how.

disallowance of depreciation could have been made on the basis of

13 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

the ALP of the international transaction of purchase of know-how.

We have noted above that the ld. CIT(A) disallowed depreciation

on the ground that the know-how was neither acquired nor used by

the assessee during the year. Au contraire, the ld. AR submitted

that the assessee, in fact, manufactured MPP products with the help

of such new technical know-how during the year and earned profit

there from. On a specific query to prove the factum of having

manufactured MPP products with the new technical know-how and

actually sold the same during the year, the ld. AR submitted that

such details were furnished to the TPO during the course of the

proceedings before him and such invoices can now also be

verified. He, however, could not bring to our notice copies of

invoices depicting sale of MPP products during the year

manufactured with the help of technical know-how acquired from

Chemetall Corporation, USA. Under the given circumstances, we

set-aside the impugned order and remit the matter to the file of

AO/TPO for vetting the assessee’s contention of having sold MPP

products, manufactured with the help of technical know-how

acquired from Chemetall Corporation, USA, during the year under

consideration. If the contention is found to be correct, then

depreciation should be allowed on the ALP of the international

transaction of acquiring technical know-how fee determined by the

14 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

TPO in the second remand report at Rs.6,07,50,277/-. In case the

assessee fails to satisfy the AO in this regard, then the

disallowance made by the AO amounting to Rs.92.33 lakhs, made

with reference to payment of Rs.7.27 crore, is required to be

upheld. Needless to say, the assessee will be allowed a reasonable

opportunity of hearing in such proceedings.

against the confirmation of addition of Rs.3,57,000/- towards

payment of royalty.

of royalty was not required as the assessee did not acquire the

impugned intangible asset during the year nor used it. The ld.

CIT(A) upheld the assessment order on this point.

material on record. The ld. AR submitted that the authorities

below erred in making and confirming the disallowance of Rs.3.57

lakhs towards payment of royalty. It was submitted that the

assessee, at no stage, claimed deduction for such a sum. In view

of the above submission made by the assessee, we are satisfied that

it would be in the fitness of things if the impugned order on this

15 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

score is set aside and the matter is restored to the file of AO. We

order accordingly and direct him to examine the assessee’s claim

in this regard. If it is found that the assessee did not claim any

deduction for a sum of Rs.3,57,000/- towards royalty, then

obviously there can be no question of making disallowance of such

a sum. In the otherwise scenario, the AO will decide as per law.

of disallowance of Rs. 1.09 crore.

time compensation of Rs.1.26 crore for termination of Agency

Agreement with its AE. Such a sum was offered for taxation. The

assessee benchmarked this international transaction along with

other five transactions in a combined way under the TNMM. The

TPO computed the ALP of this international transaction at Rs.2.35

crore by anticipating commission receipt for five subsequent years.

He then averaged such commission on gross basis and found out

the ALP at Rs.2.35 crore. This led to the recommendation of the

transfer pricing adjustment of Rs.1.09 crore, which was made by

the AO in the final order. The ld. CIT(A) countenanced the same,

against which the assessee has approached the Tribunal.

16 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

material on record. The TPO has determined the ALP of the

international transaction of `Receipt of one time compensation’ in

lieu of commission income at Rs.2.35 crore by considering the

average of gross commission income for succeeding five years.

The ld. AR has not, in principle, disputed the mechanism of the

TPO. We are in agreement with the view point of the TPO that

income for the subsequent five years should have been taken into

consideration rather than the preceding years, as has been put forth

on behalf of the assessee before us. However, we cannot

countenance the view of the TPO in considering the gross amount

of commission as the basis for determining the ALP of the

compensation. It is only the net amount, that is, after deducting the

expenses from the gross receipt, which comes to the coffers of the

assessee and constitutes his income. Determining the ALP of such

a transaction by estimating gross receipts, would amount to taxing

on the basis of receipts, rather than income, which is

impermissible. Under these circumstances, we set aside the

impugned order and remit the matter to the file of AO/TPO for

determining the ALP of the international transaction of `Receipt of

one time compensation’ afresh on the basis of average of

17 ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

succeeding five years commission on net basis. Needless to say, the assessee will be allowed a reasonable opportunity of hearing.

Order pronounced in the Open Court on 18th December, 2018.

Sd/- Sd/- (PARTHA SARATHI CHAUDHURY) (R.S.SYAL) JUDICIAL MEMBER VICE PRESIDENT पुणे Pune; �दनांक Dated : 18th December, 2018 सतीश आदेश क� क� क� �ितिलिप क� �ितिलिप �ितिलिप अ�ेिषत �ितिलिप अ�ेिषत अ�ेिषत/Copy of the Order is forwarded to: अ�ेिषत आदेश आदेश आदेश 1. अपीलाथ� / The Appellant; 2. ��यथ� / The Respondent; 3. आयकर आयु�(अपील) / The CIT (Appeals)-13, Pune 4. The Pr. CIT-5, Pune िवभागीय �ितिनिध, आयकर अपीलीय 5. अिधकरण, पुणे “बी” / DR ‘B’, ITAT, Pune; 6. गाड� फाईल / Guard file. // True copy // आदेशानुसार आदेशानुसार आदेशानुसार/ BY ORDER, आदेशानुसार

// True Copy // Senior Private Secretary आयकर अपीलीय अिधकरण ,पुणे / ITAT, Pune

ITA No.1720/PUN/2016 M/s. Chemetall Rai India Limited

Date 1. Draft dictated on 17-12-18 Sr.PS 2. Draft placed before author 17-12-18 Sr.PS 3. Draft proposed & placed before the JM second member 4. Draft discussed/approved by Second JM Member. 5. Approved Draft comes to the Sr.PS/PS Sr.PS 6. Kept for pronouncement on Sr.PS 7. Date of uploading order Sr.PS 8. File sent to the Bench Clerk Sr.PS 9. Date on which file goes to the Head Clerk 10. Date on which file goes to the A.R. 11. Date of dispatch of Order. **