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Income Tax Appellate Tribunal, “J” Bench, Mumbai
Before: Shri B.R. Baskaran (AM) & Shri Ramlal Negi (JM)
O R D E R Per B.R. Baskaran (AM) :
The assessee has filed this appeal challenging the order dated 24-01- 2013 passed by Ld CIT(A)-15, Mumbai and it relates to the assessment year 2008-09. The assessee is aggrieved by the decision of Ld CIT(A) rendered on the following issues:- (a) Disallowance of expenses of Royalty, technical knowhow fees and annual charges of Microsoft licencing fee by determining the ALP at NIL. (b) Disallowance of Provision for Diwali Gifts. (c) Disallowance of Gift articles (d) Disallowance of advertisement expenses. (e) Addition of receipts of Rs.3.32 lakhs reported in 26AS.
At the time of hearing, the Ld A.R did not press the ground relating to disallowance of advertisement expenses. Hence the same is dismissed as Not Pressed.
The assessee is engaged in the business of manufacture and sale of power driven pumps. In the Transfer Pricing Study report, the assessee characterised itself as a “Licence Manufacturer”. It entered into ten types of 2 Sulzer Pumps India Pvt. Ltd.
international transactions with its Associated Enterprises (AE), viz., Sulzer Pumps, Switzerland. The assessee grouped following international transactions entered with its AE and adopted TNMM method to benchmark them:- (a) Purchase of raw material (b) Sale of finished goods (c) Payment of Royalty (d) Payment of technical knowhow (e) Commission paid.
The assessee selected itself as tested party and arrived at a margin of 14.13% by adopting Profit Level Indicated (PLI) as Operating Profit/Sales. The assessee selected 11 comparables and arrived at a mean margin of 8.26%. Accordingly the assessee submitted that the transactions entered with AE were at arms length.
The TPO rejected the aggregation of above said transactions. With regard to Royalty payments, the TPO determined the ALP at NIL for the following reasons:- (a) As per the agreement entered with its AE, the assessee has no exclusive right to sell goods manufactured by it in India or overseas without the previous approval of its AE.
(b) Hence the assessee cannot be considered as “License Manufacturer”. The assessee can be considered only as a Contract manufacturer.
Since the assessee was considered as Contract Manufacturer, the TPO determined the ALP of Technical knowhow fee also at NIL.
The assessee has also paid a sum of Rs.10,87,081/- as Annual charges of Microsoft licensing fee. The AE of the assessee had entered into contract with Microsoft and the annual charges were allocated to the group entities annually for the use of Microsoft software. The assessee had adopte CUP method for benchmarking this transaction. Since the agreement was between the AE and Microsoft and further, since the auditor did not report this transaction in Form 3CEB, the TPO determined the ALP of this transaction also at NIL.
3 Sulzer Pumps India Pvt. Ltd.
The Ld CIT(A) also upheld the view of the TPO in rejecting the aggregation of the international transactions. The Ld CIT(A) also characterised the assessee as “Contract Manufacturer”. Accordingly he confirmed the disallowance of Royalty and Technical knowhow fees. With regard to technical knowhow fee, the Ld CIT(A) adduced one more reason for disallowance. The Ld CIT(A) noticed that the assessee has obtained approval from RBI for payment of Technical knowhow fee under automatic route. The said provisions of RBI allows payment of technical knowhow fee @ 5% and 8% respectively for domestic sales and Export sales. The Ld CIT(A) noticed that the payment made by the assessee has exceeded the above limits. Accordingly the Ld CIT(A) held that the disallowance is required to be made on this reason also. With regard to Annual charges paid towards Microsoft licencing fee, the Ld CIT(A) took the view that the payment has been made to M/s Sulzer Management AG from whom the assessee has not got any benefit/service. Accordingly he confirmed the order of TPO on all the three issues discussed above.
The contention of the assessee on the above said three issues are given in the written submission filed by the assessee and they are extracted below, for the sake of convenience:-
“4. Submission before the Hon'ble Income Tax Appellate Tribunal ('ITAT'), Mumbai
4.1 Payment of royalty
4.1.1 Assessee is a licensed manufacturer for both domestic as well as export market. This can be depicted from the Function, Asset and Risk Analysis documented in TPSR of the Assessee (Page 65 - 72 of PB). The learned TPO and learned CIT(A) did not reject the TPSR prepared by the Assessee.
4.1.2 Assessee has total export sales of INR 87.63 crores (page 26 of PB) of which export to AEs was INR 37.70 crores (page 27 of PB). Thus, the Assessee has directly exported to third party customers in overseas market. If the Assessee was a contract manufacturer in export market then it would have exported only to its AEs and not to third party
4 Sulzer Pumps India Pvt. Ltd. customers. This indicates that Assessee is license manufacturer and not contract manufacturer.
4.1.3 The learned CIT(A) relying on clause 2.1 to 2.4 of inter-company license agreement concluded that Assessee has exclusive right to manufacture the contract products in India but does not have exclusive right to sell or export anywhere without previous consent in writing from AE (page 16 of CIT(A) order). On this point the Assessee wishes to submit that the business of Sulzer Group (including that of the Assessee) is based on tender floated by prospective customers. Against these tender, bid is to be submitted. In order to avoid multiple bids from Sulzer Group for the same customer tender, a clause (i.e. clause 2.3) is inserted in the license agreement that requires Assessee to take previous consent from its AE. Thus, the clause in license agreement does not restrict Assessee from exporting its products.
4.1.4 The Assessee also wishes to submit that as per clause 2.4 of the inter-company license agreement (page 112 of PB) if the products manufactured by the Assessee are exported in international market at competitive price then AE may purchase the product from the Assessee. This indicates that transaction between the Assessee and its AE take place on principal to principal basis. If the Assessee was a contract manufacturer then the commercial arrangement between the Assessee and its AE would have been on cost plus mark-up basis (i.e. the Assessee would have earned limited steady mark-up on its cost). Thus, the Assessee cannot be considered as contract manufacturer.
4.1.5 Further, the Assessee also wishes to submit that the learned TPO has not used any of the prescribed transfer pricing method to determine arm's length price of royalty as NIL. On this point the Assessee wishes to place reliance on following ruling where it was held that one of the prescribed transfer pricing method should be used to benchmark international transaction:
• LG Electronics India Private Limited [TS-96-HC-2015(DEL)-TP] (Para 22.10 and 22.11 at page 128 and 129 of the ruling),
• Det Norske Veritas A/S [TS-76-ITAT-2016(Mum)-TP] (Para 9 at page 6 and 7 of the ruling); and • Johnson & Johnson Ltd [TS-171-HC-2017(BOM)-TP] (Para 4(d) at page 6 of the ruling)
4.1.6 The Assessee has benchmarked this transaction using one of the prescribed transfer pricing method i.e. Transactional Net Margin Method ('TNMM'). Since the transaction of payment of royalty is closely
5 Sulzer Pumps India Pvt. Ltd. and intrinsically linked to the primary function of manufacturing of pumps undertaken by the Assessee and accordingly it is aggregated and benchmarked together under TNMM at entity level. On this point the Assessee would like to place reliance on the following rulings, in these rulings it was held that closely linked international transaction can be aggregated under TNMM:
• Sony Ericson Mobile Communications India Pvt Ltd [TS-96-HC- 2015(DEL)-TP] (Para 91 at page 64 and 65 of the ruling);
• Cummins India Limited [ITA No. 115/PUN/2011] (Para 16 at page 24 to 26 of the ruling); and • Demag Cranes & Components (India) Pvt. Ltd [TS-765-ITAT- 2012(PUN)-TP] (Para 30, 31, 32 and 34 at page 21 to 25 of the ruling).
Thus, Assessee has benchmarked the transaction using one of the prescribed method and concluded that the transaction of payment of royalty to technology is at arm's length price. Accordingly, the benchmarking analysis undertaken by the Assessee should be accepted and adjustment made by the learned TPO/AO/CIT(A) should be deleted.
4.1.7 The Assessee also wishes to submit that the royalty rate is approved by RBI under automatic route which provides payment of royalty at 5% on domestic sales and 8% on export sales plus a lumpsum payment of fixed fees. Since the rate which royalty is paid by the Assessee is approved by RBI it should be treated to be at arm's length price.
4.2 Payment of technical knowhow
4.2.1 As discussed in point 2 and 3 above, the learned TPO and CIT(A) recharacterized Assessee as contract manufacturer. On this point of the Assessee wishes to submit that the Assessee is a licensed manufacturer and not contract manufacturer. For detailed reason and submission of the Assessee kindly refer to point 4.1.1 to 4.1.4 above.
4.2.2 Further, the Assessee also wishes to submit that the learned TPO has not used any of the prescribed transfer pricing method to determine arm's length price of this transaction. Whereas, Assessee has used TNMM to benchmark this transaction. For detailed submission on this point please refer point 4.1.5 and 4.1.6 above.
4.2.3 The learned CIT(A) contented that license agreement and the payment of technical knowhow by the Assessee is under the automatic
6 Sulzer Pumps India Pvt. Ltd. route. Under the automatic route the payment of royalty for technology/knowhow has been allowed to the maximum of 5% of net sales in domestic market and 8% of export sales as per the RBI circular, (page 19 of CIT(A) order). The payment of fixed technical know-how of CHF 246,300 by the assessee to its AE is above the 5% and 8% of the net sales in the domestic and export sale respectively. Accordingly, the payment was also disallowed on this ground. (Page 19 of CIT(A) order). On this point the Assessee wishes to submit that under the RBI circular [RBI/2004/74 dated 24 February 2004] relating to automatic route, RBI has permitted payment of lump-sum technical fees not exceeding USD 20 lacs under automatic route and such lump-sum fees is over and above royalty at rate of 5% on domestic sales and 8% on export sales (page 159 ofPB). Accordingly, the lump-sum technical knowhow paid by the Assessee should be not be disallowed.
4.2.4 Further, the Assessee also wishes to submit that the payment of lump-sum technical know fee is capitalized by the Assessee in its books (page 12 and 17 of PB). Without prejudice to above submission, even if adjustment is to be made it should be restricted to value of depreciation/amortization during FY 2007-08.
4.3 Annual charges of Microsoft Licensing fees
4.3.1 The contention of learned TPO and CIT(A) is that the transaction of payment of Microsoft license is reported in Form 3CEB as being paid to Sulzer Management AG and not to Sulzer Management Ltd. Whereas, the Microsoft agreement submitted to the learned TPO and CIT(A) reflects that the agreement is between Sulzer Management Ltd and Microsoft. Thus, the party to whom payment is made and reported in Form 3CEB is different from party with whom Microsoft entered licensing agreement. On this point the Assessee wishes to submit that Sulzer Management AG and Sulzer Management Ltd are same companies having two different suffix. For this purpose the Assessee submitted document from Commercial Register of the Canton of Zurich which indicates that Sulzer Management AG is also known as Sulzer Management Ltd. Hence we humbly submit that the adjustment made should be deleted.”
The Ld D.R, however, submitted that the assessee could not explain as to how these transactions are inextrically connected. He submitted that the Ld CIT(A) has taken the view that each of the transactions is different/distinguishable and hence they should be evaluated separately. The 7 Sulzer Pumps India Pvt. Ltd.
Ld A.R placed his reliance on the decision rendered by Delhi bench of ITAT in the case of Cairn India Ltd (ITA No.1459/Del/2016 dated 09-10-2017).
We heard the parties and perused the record. We notice that the tax authorities have considered the assessee as a “Contract Manufacturer” and accordingly disallowed the Royalty and Technical knowhow expenses. In the written submissions, the assessee has demonstrated that the purpose of obtaining approval for sales from its AE is to avoid competition between the AEs. The assessee has also submitted that out of the total export sales of Rs.87.63 crores, the exports made to AEs was only Rs.37.70 crores and the remaining exports have been made to non-AEs. Had the assessee been a contract manufacturer, it could not have sold the goods to non-AEs. Accordingly it was submitted that the restrictions placed by the AE in the agreement entered with the assessee was with the objective of ensuring smooth business operations. We find merit in the said contentions of the assessee. If the assessee was really a contract manufacturer as considered by the tax authorities, it would be getting only a fixed amount of profit and further it would not be able to export goods on its own account. The facts available on record would show that the assessee has been selling goods to Non-AEs also. Accordingly we hold that the assessee should be considered as a Licence Manufacturer in the facts and circumstances of the case.
Since we have held that the assessee is licenced manufacturer, the basic foundation on which the disallowances of royalty and technical knowhow expenses were made would fail. Further the assessee has also pointed out that the TPO has not adopted any of one of the prescribed methods for benchmarking the transactions. Further the assessee has also taken support of certain case laws to contend that the aggregation of intrically connected transactions and determining the ALP of the transactions at entity level under TNMM method was justified. We notice that the TPO had no occasion to examine all these contentions, since he considered the assessee to be a contract manufacturer. Accordingly we are of the view that the issues relating
8 Sulzer Pumps India Pvt. Ltd. to Royalty and Technical knowhow requires fresh examination at the end of the AO/TPO. Accordingly we set aside the order passed by Ld CIT(A) on these two issues and restore the same to the file of AO/TPO for examining them afresh in accordance with the law.
With regard to disallowance of Annual charges of Microsoft licence fees, we notice that the reasoning given by the tax authorities to determine the ALP at NIL is not justified. The Ld A.R submitted that the Sulzer management AG and Sulzer Management Ltd are one and same company. The Tax authorities were under the impression that there is variation between the transactions reported in Form 3CEB and the actual agreement submitted by the assessee due to existence of different names, which according to assessee refers to same company, referred above. The assessee has furnished a document from Commercial Register of the Canton of Zurich to show that both the names refer to the same company. In any case, this transaction has also not been benchmarked under any of the recognised methods by the TPO. Accordingly we restore this issue also to the file of AO/TPO for examining it afresh.
The next issue contested by the assessee relates to the disallowance of Provision for Diwali gifts to employees. The assessee provided a sum of Rs.9.00 lakhs under this head and claimed the same as expenses. The AO took the view that this expenditure is akin to bonus and hence it is allowable only on payment basis u/s 43B of the Act. The AO also took the view that this expenditure may be considered as Contingent in nature, as it is not certain that the concerned employees shall continue in service upto Diwali. Accordingly he disallowed the claim and the Ld CIT(A) also confirmed the same.
The Ld A.R submitted that the provision of Rs.9.00 lakhs made as on 31.3.2008 has been reversed by the assessee in the succeeding year, meaning thereby, the same was offered as income in the succeeding year. The Ld A.R submitted that if the disallowance is confirmed by the Tribunal in this year,
9 Sulzer Pumps India Pvt. Ltd. then the assessee may be given relief in the succeeding year by giving appropriate directions to the assessing officer.
We heard Ld D.R on this issue and perused the record. We notice that the assessee has not given any valid reason for making provision towards diwali gifts payable to employees as at 31.3.2008, i.e., for the diwali 2008, which normally falls in Oct/Nov 2008, the assessee has made provisions as on 31.3.2008. Accordingly we are of the view that the disallowance made by the AO was justified on the reasoning that it may not relate to the year ending 31.3.2008. However we find merit in the alternative submissions of the assessee. The assessee claims to have reversed the provision in the succeding year, meaning thereby, the assessee has offered the amount of Rs.9.00 lakhs as its income in AY 2009-10. Since the disallowance has been confirmed by us, the same would result in double assessment of same item of income, if the income of Rs.9.00 lakhs voluntarily offered by the assessee in AY 2009-10 is not reduced. Accordingly we direct the AO to examine the claim of the assessee and reduce the amount of Rs.9.00 lakhs in AY 2009-10, if he is satisfied with the claim of the assessee. The assessee may also move appropriate petition before the AO in this regard.
The next issue relates to the disallowance of gift articles. The assessee claimed a sum of Rs.40.26 lakhs towards expenses on gift articles. The AO noticed that they consisted of expenses on purchase of dry fruits, purchase of sony camera, decorative pieces etc. The AO took the view that the assessee has not demostrated as to how these gifts would benefit the company. He noticed that the assessee has also debited/provided expenses on gifts given to employees, which amounted to Rs.34.50 lakhs. The AO did not disturb it. Out of the remaining amount of Rs.6.06 lakhs (sic), the AO disallowed 20% thereof, which amounted to Rs.1,21,285/-. The Ld CIT(A) also confirmed the same.
10 Sulzer Pumps India Pvt. Ltd.
We heard the parties on this issue and perused the record. We notice that the AO has disallowed a portion of expenses on estimated basis, since the assessee could not give explanations to the satisfaction of the AO. The Ld CIT(A) also was not convinced with the contentions of the assessee and hence he has confirmed the disallowance. Since the disallowance has been made on estimated basis on certain short falls, we do not find any infirmity in the disallowance so made. Accordingly we confirm the order passed by Ld CIT(A) on this issue.
The last issue relates to the addition made on the basis of 26AS statement. Before us the assessee has filed a reconciliation statement, which requires examination at the end of AO. Accordingly we set aside the order passed by Ld CIT(A) on this issue and restore the same to the file of the AO for examining it afresh.
In the result, the appeal filed by the assessee is treated as partly allowed for statistical purposes. Order has been pronounced in the Court on 31.10.2018.