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Income Tax Appellate Tribunal, BANGALORE BENCH ‘A’
PER SHRI N.V VASUDEVAN, JUDICIAL MEMBER : This is an appeal by the assessee directed against the order dated 13/1/2017 of Asst. Commissioner of Income-tax, Circle-3(1)(1),
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Bangalore relating to assessment year 2012-13 in respect of an order passed u/s 143(3) r.w.s 144C(13) of the Income Tax Act, 1961 (Act).
The assessee is a company registered under the Companies Act, 1956. The assessee is engaged in manufacture of carbon block cartridges used for removal of harmful contaminants from drinking water. The assessee commenced its business with a vision to channel technology and resources to make drinking water affordable to more people around the world.
M/s Filtrex Holdings Pte. Ltd. (FHPL) is a company incorporated in Singapore and tax resident of Singapore. FHPL are pioneers in water purification industry. They have several registered patents and trademarks in their name. They licensed to the assessee technology owned by them to manufacture and sell carbon block cartridge. For right to use the technology, the assessee paid royalty of 9.86 crores to FHPL.
Filtrex International Pte. Ltd., (FIPL) is also a company incorporated in Singapore under tax resident of Singapore and it rendered administrative, financial and marketing services. The assessee paid sum of Rs.2.54 crores during the relevant previous year as consideration for the services rendered by FIPL.
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It is not in dispute that the assessee FHPL and FIPL are associated enterprise and therefore, the transaction of licensing of royalty and rendering of management services were international transactions and in view of the provisos of sec. 92 of the Act, income arising from international transaction has to be determined having regard to Arms Length Price (ALP). The following chart will be explained as to how the assesee and FHPL and FIPL are associated enterprises and the international transactions between the associated enterprises.
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The Assessing Officer made a reference to the TPO for determination of ALP of the international transaction between the assessee and FHPL and FIPL. As far as the determination of ALP with regard to transaction between the assessee and FHPL and FIPL is concerned, the TPO rejected the TP analysis justifying price paid for the international transactions paid as at arm’s length. The TPO was of the view that the assessee failed to explain the cost benefit analysis for the payment of royalty as well as availing management services from AEs. The conclusions of the TPO in the regard are contained at paragraph 9 of his order. Over and above the aforesaid conclusions, the TPO also placed reliance on information which he had received from the Inland Revenue authority of Singapore. It is not in dispute that the information received by the TPO from Inland Revenue Authority, Singapore was not confronted to the assessee. The sum and substance of the of the conclusion of the TPO on the basis of the information received from inland revenue authority of Singapore was that Mr. Boomi Govind who had controlling interest in FTPL was a key person who provided services and not FIPL and FHPL. The TPO thereafter concluded as follows:-
“10.9 The above facts makes it clear that the payments to FIPL & FHPL are not incurred for the purpose of the business and have been claimed to evade tax by transferring the profits to FIPL & FHPL assessed in Singapore at lower rate of tax. 10.10 The decision of the Hon'ble Kerala High Court in the MIL Controls Ltd. vs. CIT (340 ITR 190) is pertinent, in which the Assessee Company made the payment for the Corporate
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Services rendered by one of the Associate Enterprises in respect of which before the Assessing Authority except the statement of services in broad terms (Similar to the appellant), the assessee did not furnish any details about the nature of the services rendered by the payee Company (Similar to the appellant). The Hon'ble High Court held that "The finding of these authorities is that the appellant did not furnish specific details about the services rendered and what is stated is about the broad support and help received by the appellant from the group company to justify payments. We do not know why the appellant could not furnish break up details of the payments made with reference to the corresponding service rendered for procuring orders, for use of the facilities of the payee company etc. The appellant's contention that the claim is allowable merely because the payment is made and the same bona fide cannot be accepted. This is because the payee is related company within the group and therefore the standard of proof required for allowing the claim is more than what is required in other cases. If the payment was to a stranger and bona fide, presumption of reasonableness of payment would apply but not when payments are between related parties. This is because in the case of related companies, beneficiaries are the same set of people and therefore unless details are furnished justifying the payment of services charged the Department is not bound to allow the claim." 11. In view of the above, the payments of the fees for Technical Services and fees for the Management Consultancy allegedly to FHPL and FIPL, respectively, in the case of the taxpayer is not at all justified. In view of the above it is concluded that the ALP is nil on the basis that an independent entity in a comparable situation would not pay any amount. Thus the arm's length price of these payments is treated as Rs. Nil due to inadequacy of the taxpayer's argument and the entire payment of Rs. 12,40,74,000/- is treated as an adjustment U/s 92CA of the Income Tax Act, 1961.”
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Aggrieved by the adjustment to ALP suggested by the TPO, the assessee preferred objections before the Dispute Resolution Panel (DRP). The DRP concurred with the view of the TPO. The following were the conclusions of the DRP in this regard “7.1 The assessee has made detailed submissions in relation to the above objections. The submissions of the assessee have duly been considered. The issue has been discussed in detail by the TPO in para 8 to 11 of his order. The assessee has argued that detailed information regarding services rendered by AE was provided to the TPO. However, on perusal of the details furnished, it is observed that although the assessee had provided copy of the relevant agreement, it did not provide any bifurcation of services rendered by the AE under various heads within the broad heads specified. The assessee didn't provide the details of amounts paid in respect of each of such services provided by the AE. The assessee didn't produce any evidence regarding the actual services rendered by the AE and how the same were quantified. No primary evidence regarding rendering of services was provided. Assessee just relied on the invoices and description of the nature of services to support its claim. These issues have been discussed in detail by the TPO in para 9 and 10 of his order. A perusal of the Management services agreement with FIPL shows that the agreement has been substantially amended wef AY 2011..12 as compared to earlier years. The remuneration/Fee clause is now termed as Royalty and the same is as follows:
"4.2 In consideration for the services indicated in Article 3, Filtrex-India shall effect a Lump Sum payment of USD 500,001-Five Lakhs US Dollars only) manufactured by it during the financial year but in all the said payment per annum and the basis, the currency of payment, the ceiling for the payment have been determining after due valuation
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and negotiation between the Parties to the Agreement;" 7.2 This shows that even the clause relating to the royalty is vague as the words used are "a lump sum payment of USD 5,00,000/- (Five lakh US Dollars only) manufactured by it during the financial year". The assessee could not explain the above aspect. No two independent parties at arm's length would enter into such a vague agreement. This also shows that the agreement is just a paper meant for the tax authorities and the same does not have any relevance as far as the assessee and its AE are concerned as their basic purpose is shifting of profits from assessee to AE. Further, amount of fee to be paid is independent of the actual services rendered by AE. The fee has been decided without indicating the extent of resources, which will be put up at the disposal of the assessee by the AE. The agreement doesn't provide for any safeguard to the assessee in case there is any deficiency in services provided by the AE and the assessee has to pay to the AE irrespective of quality or quantum of services rendered by it. Further, as pointed out by the TPO, FIPL does not have any resources to render these services. FIPL having its revenue from the assessee only and it is not having receipts from any other business activity. Although the agreement says that the ceiling of USD 5,00,000/- has been determined after due valuation and negotiation, however nothing has been brought on record to substantiate the same. In earlier years (upto AY 2010-11), the ceiling was stated to be sum of direct and indirect costs incurred by the AE, however now the same has been vaguely defined so that the AE cannot be asked by the assessee to show its correctness. Although the assessee is obliged to make available its records for inspection to be carried out by the AE, however, the assessee cannot inspect the records of AE. The assessee could not explain as to what purpose will be served for AE by inspecting the records of the assessee, when the payment itself was lump sum. These aspects show the true nature of the transaction i.e. it is only a paper transaction without any
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actual services and the agreement has been drafted by just picking up some clauses from here and there, so as to make it look as a genuine agreement. Considering above the action of the TPO in treating ALP of the transaction relating to management fee as Nil, cannot be faulted with and the objection of the assessee is not accepted. 7.3 As regards technical services, the assessee has failed to controvert the findings of the TPO that the alleged services were rendered to it by Sh. Bommi Govind and not by FHPL. This information gets corroborated by the information supplied by Singapore Authorities (para 10 of the TPO's order), Sh. Bommi Govind is having 100% indirect control over the assessee company as 85.04% shares of the assessee company are held by FHPL and Sh. Bommi Govind owns 100% shares equity of FHPL. Remaining 14.95% shares of the assessee company are owned by FIPL which is a 100% subsidiary of FHPL. Thus Sh. Bommi Govind has 100% control over the assessee company. Further, a perusal of the Technical collaboration agreement with FIPL shows that the agreement has been substantially amended for the year under consideration. The clause for Royalty is as follows:
"4.2 In consideration for the services indicated in Article 3, Filtrex-India shall effect a Royalty payment of 0.5 US Dollar for each of the active carbon block manufactured by it during the financial year but in all the said payment shall not exceeding US Dollar 19,40,000/- (Nineteen Lakhs Forty Thousand US Dollars Only) per annum and the basis, the currency of payment, the ceiling for the payment have been determining after due valuation and negotiation between the Parties to the Agreement;" Although the Technology Transfer Agreement says that the Fee is $0.50 per carbon block, but ceiling has now not been defined on the basis of actual direct and indirect costs of the
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AE. Instead, as for the case of agreement with FIPL, the agreement with F1-JPL also says that the ceiling of USD 19,40,000/- has been determined after due valuation and negotiation ever nothing has been brought on record to substantiate the same. Here too, in earlier years (upto AY 2010-11), the ceiling has been vaguely defiend so tht the AE cannot be asked by the assessee to show its correctness. Since FHPL had only paid remuneration to Sh.Bommi Govind, being Director, the maximum expenditure the AE could have claimed from assessee could have been such amount of remuneration. These aspects show the true nature of the transaction i.e. it is only a paper transaction without any actual services and the agreement has been drafted by just picking up some clauses from here and there, so as to make it look as a genuine agreement. Considering above the action of the TPO in treating ALP of the transaction relating to royalty/technical service fee as Nil, cannot be faulted with and the objection of the assessee is not accepted.”
The AO passed final order of assessment, wherein he added to the total income, the adjustment to the ALP as suggested by the TPO in his order, which was confirmed by the DRP.
Aggrieved by the final assessment order dated 13/1/2017, the assessee has preferred the present appeal before the Tribunal.
The grounds of appeal raised by the assessee before the Tribunal reads as follows:-
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GENERAL GROUNDS
The Orders passed by learned Assistant Commissioner of Income Tax, Circle - 3(l)(1), Bangalore (hereinafter referred as "AO" for brevity), learned Deputy Commissioner of Income Tax (Transfer Pricing Officer) - 1(2)(2), Bangalore (hereinafter referred as "TPO" for brevity) and the Honourable DRP-2 ("AO", "TPO" and DRP collectively referred as "lower authorities" for brevity) are bad in law and liable to be quashed.
The learned AO has erred in taking CIT's approval and erred in making reference to TPO for computation of arm's length price of international transactions. The "Assessing Officer" of the Assessee as per Principal CCIT's order dated 15.11.2014 being ACIT/DCIT, Circle 3(l)(1), the approval taken by and the reference made by the learned ACIT, Circle 3(1)(2) is invalid and bad in law. Consequently, the approval given by the CIT, entire proceedings and the draft assessment order passed are also non-est., bad in law and liable to be quashed; 3.The lower authorities have erred in passing the order under section 92CA and the assessment order, without providing the information received from the Inland Revenue Authority of Singapore in pursuance to the reference under India - Singapore DTAA. The orders so passed making adjustments / additions to income returned by relying on the said information but without providing the said information to the Appellant for rebuttal is contrary to the principles of natural justice, contrary to Article 28 of India - Singapore DTAA and consequently bad in law and liable to be quashed. GROUNDS RELATING TO TP LEGAL GROUNDS
4.The lower authorities have erred in;
i.Making transfer pricing adjustment of Rs. 12,40,74,000/-;
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ii.Making a reference to Transfer Pricing Officer for determining arm's length price without demonstrating as to why it was necessary and expedient to do so;
iii.Passing the order without demonstrating that the Appellant had motive of tax evasion; iv.Not appreciating that there is no amendment to the definition of "income" and the charging or computation provision relating to income under the head "Profits & Gains of Business or Profession" do not refer to or include the amounts computed under Chapter X and therefore addition made under Chapter X is bad in law; and v.Not appreciating that there being no disallowance under section 40A(2) for royalty payment and management consultancy fee adjustment under Chapter X ought not to be made.
GROUNDS RELATING TO TP ADJUSTMENT FOR ROYALTY AND MANAGEMENT CONSULTANCY FEE:
5.Without prejudice to above contention that re-assessment proceedings are bad in law, the lower authorities have erred in: i.Ignoring the business, commercial and industry realities and economic circumstances applicable to the Appellant;
ii.Ignoring the Transfer Pricing analysis undertaken by the Appellant and performing fresh transfer pricing analysis without rejecting the TP analysis performed by the Appellant; iii.Rejecting TNMM applied by Appellant to justify its international transactions with AE on unjustifiable grounds;
iv.Not appreciating that Appellant had adopted TNMM at the entity level, in which process, the royalty payment and
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management fee was considered and accordingly benchmarked; and v. Not appreciating that once the net profit is tested on the touchstone of arm's length price, it pre-supposes that the various components of income and expenditure considered in the process of arriving at the net profit are also at arm's length. 6.Assuming without admitting that the royalty and the fee for management consultancy is to be separately evaluated on the touchstone of arm's length principle, the lower authorities have erred in adopting CUP method without justifying how the same is the most appropriate method in the case of the Appellant. Further, the lower authorities have also erred in determining the ALP at 'NIL' without considering any comparables under CUP method. 7.The lower authorities have erred in:
i.Concluding that the Appellant has not provided any evidence/document with respect to technical know-how provided and services rendered by the AE; ii.Applying benefit test which has no statutory recognition. Even otherwise, the conclusion that Appellant has not received benefit from the technical know-how provided and services rendered by AE is without basis; iii.Relying on information received from Inland Revenue Authority of Singapore without sharing the same with the Appellant. Even otherwise based on such information, the lower authorities have drawn incorrect conclusion that the Appellant has not received any economic benefit from assistance received from the AE's; iv.Concluding, without basis, that ALP is 'NIL' on the contention that an independent entity in a comparable situation would not pay any such amount;
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v. Concluding that arm's length price of royalty and management consultancy fee at 'NIL' without appreciating that the amount were paid based on the Agreement entered into with AE and was for providing technical know-how and various kinds of services to the Appellant; vi. Ignoring the fact that the Collaboration Agreements were approved by Government authorities and therefore royalty and management consultancy fee payment should be considered as at arm's length;
vii.Not considering the Appellant's submissions and not appreciating that the Appellant had submitted evidences regarding actual receipt of technical know-how and services from AE; and viii. Disregarding the alternative analysis performed by the Appellant, wherein comparable third party agreements were submitted to demonstrate that the price charged by AE's was in tune with the price charged by third parties in similar scenario. 8.The lower authorities have erred in not appreciating that in the assessment proceedings of AE, the returned income has been accepted thereby presupposing that the amount received by the AE from the Appellant is at arm's length and therefore amount paid by the Appellant should also be considered as at ALP in its hands. 9.Assuming without admitting that the adjustment is to be made, the lower income tax authorities have erred in not allowing the benefit of the +1-5% range prescribed in the proviso to section 92C(2). OTHER GROUNDS 10. The TPO have erred in levying interest of Rs 2,32,30,508/- under section 234B. On the facts and circumstances of the case,
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interest under section 234B is not leviable. The Appellant denies its liability to pay interest under section 234B and section 234C. 11. Further, the lower authorities have erred in levying interest of Rs. 16,063/- under section 234D. On the facts and circumstances of the case, interest under section 234D is not leviable. The Appellant denies its liability to pay interest under section 234D. The Appellant submits that each of the above grounds/ sub- grounds are independent and without prejudice to one another. The Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal, at any time before or at, the time of hearing, of the appeal, so as to enable the Income- tax Appellate Tribunal to decide the appeal according to law. The Appellant prays accordingly.”
We have heard the rival submissions. We deem it appropriate to deal with ground No.8 raised by the assessee in its appeal in which it has raised a plea that in the assessment proceedings of AEs i.e., FHPL & FIPL, the returned income has been accepted thereby presupposing that the amount received by the AE from the Assessee is at arm's length and therefore amount paid by the Assessee should also be considered as at ALP in its hands.
As far as ground No.8 raised by the assessee is concerned, the first aspect which we need to clarify is that the assessee has not raised similar plea before the DRP. This is because the facts with regard to ground No.8 emanated only after the order of the DPP. The facts as far as the ground No.8 is concerned are that the FIPL though is tax
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resident of Singapore was assessed to tax in respect of the fees for providing management service which it received from the assessee in India. The AO passed an order of assessment u/s 143(3) r.w.s 147 on 21/12/2016 in the case of FIPL. In the said order, the AO has observed as follows with regard to the services rendered by FIPL to the assessee.
“2. As per the information available on record, M/s Filtrex Technology Pvt. Ltd.(FTPL), an Indian company engaged in the manufacture and sale of carbon blocks and water purifier products, had entered into Foreign Collaboration agreement with M/s Filtrex International PTE Ltd., on 01.04.2004 and it continued to be in effect in the subsequent years as well, subject to renewal year after year. The scope of Collaboration as per the agreement entered into w.e.f. 01.04.2004 between M/s F'iltrex Technology Pvt. Ltd.,lndia & M/s Filtrex International PTE Ltd. ,Singapore, included implementation of the Global Strategy, integrating operation for environmental/ pollution reduction, helping write the process of Filtrex-India to achieve ISO 14001, introduction of Eco Carb concept to the leading companies on behalf of Filtrex-India to get the products to world class in quality, having the products tested at WQA and NSF in the United States of America and to facilitate the audit of Filtrex-India manufacturing sites in Bangalore by WQA and NSF, developing the marketing concept for GREEN CARBON, laying the foundation for ECOCARB business, writing the business plan for ECOCARB, facilitating foreign companies to visit Filtrex-India, advisory functions with respect to finance and treasury, Public Relationship and exhibitions participation, media relations, Corporate communications and marketing communications policies, Leadership training, Human Resource and Manpower Planning, Information Technology Services, any other service required from time to time by Filtrex-India, etc. In connection with rendering of these services, M/s Filtrex
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International PTE Ltd. had received a sum of Rs. 2.54 crores from FTPL during the FY 2011-12. The receipts had been made by FTPL as the consideration for utilizing the management services provided by FIPL. The amount. received by FIPL is assessable as F'TS both under the provisions of Income-Tax Act, 1961 and DTAA between India and Singapore. In view of these facts, the amount of Rs. 2.54 crores received by M/s Filtrex International PTE Ltd. had not been offered to tax and hence the AO had reason to believe that this income of Rs. 2.54 crores had escaped assessment for AY 2012-13.”
The AO accepted the consideration received by FIPL from the assessee as appropriate and did not make any adjustment on account of ALP. The assessee had filed his return of income declaring the income received from the assessee u/s 115A of the Act at 10% of the gross receipts. This was accepted by the AO in the assessment.
Similarly, FHPL also filed the return of income and for assessment year 2012-13 offering the royalty income received from the assessee to tax. The following is the description of the royalty income received by FHPL from the assessee, as described in the order of assessment in the case of FHPL.
“2. As per the information available on record, M/s Filtrex Technology Pvt. Ltd. (FTFL), an Indian company engaged in the manufacture and sale of carbon blocks and water purifier products, had entered into Foreign Collaboration agreement with M/s Filtrex Holdings PTE Ltd., on 01.04.2004 and it continued to be in effect in the subsequent years us well, subject to renewal year after year. The scope of Technology Transfer as per the agreement entered into w.e.f. 01.042004 between M/s
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Filtrex Technology Pvt. Ltd., India & M/s Filtrex Holdings PTE Ltd., Singapore, was provision of o: gas injected plasma treatment of carbon and binders, process know how to increase the performance of carbon blocks using surface modification, know-how of Nano s technology to be incorporated into carbon, general know how of Nano transitional me like copper and nickel to be impregnated in carbon, know how for electro kinetic generator technology, licensing of patent on a non exclusive basis to be used for gray applications, all information regarding such know how, charts, drawings, process sheets etc for utilization and implementation in setting up of Hosekote unit, technical service. and assistance in any areas of know how etc. In connection with rendering of these services, M/s Filtrex Holc1ins PTE Ltd. had received a sum of Rs. 9.86 crores from FTPL during the fl 20 11- 11) The receipts had been made by FFPL as the consideration for utilizing the technical services provided by FHPL. The amount received by Fl-IPL is assessable as FTS both under the provisions of Income-Tax Act, 1961 and DTAA between India and Singapore. In view of these facts, the amount of Rs. 9.86 crores received by M/s Filtrex Holdings PTE Ltd. had not been offered to tax and hence the AG had reason to believe that this income of Rs. 9.86 crores had escaped assessment for AY 2012-13.”
The assessee offered to tax royalty income on gross basis u/s 115A of the Act at 10% of the gross receipts. In the order of assessment passed by the AO in the case of FHPL dated 21/12/2016, the AO has set out the various terms of the agreement for use of IPR owned by FHPL by the assessee and finally the AO accepted the income returned by FHPL.
The ld counsel for the assessee submitted before us that the receipts from the assessee by FHPL and FIPL were considered as
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appropriate and at arm’s length in the assessment of FIPL and FHPL by the Indian tax authorities. He highlighted the fact that in the assessment of FIPL and FHPL, the fact that the services were rendered and right to use Intellectual Property Rights (IPRs) were given for which royalty were paid has been duly recognized. The prayer of the learned counsel was that the revenue having accepted the arms length prices in the case of FIPL and FHPL should not be permitted to take the different stand when it comes to assessment of the assessee who is the person who paid the consideration to FIPL and FHPL. In this regard, the ld counsel for the assessee filed before us copy of the decision of the ITAT, Bangalore ‘A’ Bench in the case of M/s UE Development India Pvt. Ltd., Vs. DCIT in IT(TP)A No.1104/Bang/2011 and IT(TP)A No.284 to 286/Bang/2012 for assessment years 2007-08 and 2004-05 to 2006-07, the order is dated 30/8/2013. In the aforesaid case, the facts were identical in as much as the assessee made payments to its AE and the question in the case of the assesee was with regard to the ALP of the sum paid to AE. The AE was also assessed to tax in India on the receipts from the assessee. In the assessment of AE recipient, the consideration was found to be at arms length. On the above facts, the question before the Tribunal was as to whether the payment by the assessee to the AE can be said to be not at arms length. The tribunal held as follows:-
“13. Having heard both the parties and having considered the rival contentions, we find that the TPO has accepted the expenditure incurred by the AE to be at arms length but has not
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accepted the income of the assessee to be at arms length. Both. the asessees are different legal entities with different components of expenditure and income. But when a transaction is entered into with an AE, it has to be at arm’s length from each other. If the transaction is found to be at ALP in the ahnds of the parties, then the other end of the transaction also has to be considered to be at arm’s length. Therefore, when the TPO has accepted the transaction to be at arm’s length in the hands of the AE, then the transaction will have to be accepted to be at arm’s length in the hands of the assessee also. In view of trio same, we are of the opinion that the DRP was right in holding that what is true of the other end of the transaction but it erred in holding that the remedy is to suitably substitute the ALP determined in the hands of assessee also in the hands of the AE. As rightly pointed out by the learned counsel for the assessee. the DRP can only give directions as regards the determination of ALP in the hands of the assessee before it. It cannot give directions to consider the issue n the hands of an assessee whose case is not before it, It is for the relevant TPO/AO to, take action in accordance with law in the light of facts and circumstances of the case before them applying their mind independently and not on the directions of DRP or any other authority in another case. Therefore, the relevant ground of appeal on this issue is allowed.”
The learned counsel for the assessee therefore submitted that the Revenue having accepted the ALP in the assessment of the AEs cannot be allowed to take a opposite stand in the case of assessee.
The ld DR on the other hand submitted that the acceptance of the return of income of FHPL and FIPL by the AO cannot give raise to a presumption that the consideration paid by the assessee to FIPL and FHPL was at Arm’s length. According to him, it can at best be
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said that the rendering of services by FIPL and the licencing of IPR by FHPL have been accepted but the arm’s length price paid by the assessee to FIPL & FHPL cannot be said to have been established. In this regard, the ld DR pointed out that if it is considered that the consideration received by FHPL and FIPL was less than the ALP then the AO need not determine the ALP but can accept a higher income declared by FIPL and FHPL. The AO cannot reduce the income declared by the assessee in the return of income. Therefore according to the ld DR, the orders of assessment accepting the income declared by FIPL and FHPL by the Indian tax authorities cannot be conclusive in the matter of determination of ALP of the price paid by the assessee to FHPL and FIPL.
We have given very careful consideration to the rival submissions. As far as Gr.No.8 raised by the Assessee in its appeal is concerned, the plea of the Assessee is that in the Assessment proceedings of FHPL and FIPL for the very same AY viz., AY 2012- 13, the TPO has accepted that the income shown by FHPL and FIPL was (a) for services it rendered to the Assessee and (b) that the remuneration received was at Arm’s Length. The AO of FHPL and FIPL while completing the assessment of FHPL and FIPL was fully aware of the fact that the transaction by which FHPL and FIPL received fees from the Assessee was a transaction between two Associated Enterprises (AE) and the same was an international transaction. The AO of FHPL and FIPL was therefore bound to
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determine income arising from the international transaction having regard to Arm’s Length Price as per the mandate of Sec.92 of the Act. The AO was at liberty to make a reference to the TPO to find out the ALP of the international transaction. He did not do so. In exercise of his powers not to make a reference for determination of ALP to the TPO, the AO accepted the consideration received by FHPL and FIPL as at Arm’s Length. 20. The question therefore is as to whether the fact that income declared by FHPL and FIPL has been accepted as at Arm’s Length, means that the corresponding payment by the Assessee to FHPL and FIPL should also be regarded as at Arm’s Length. The acceptance of return of income of FHPL and FIPL and the observations made in the orders of assessment passed for AY 2012-13 in their case shows that the AO of FHPL and FIPL accepted that services were in fact rendered by FHPL and FIPL and that the nature of services rendered was technical services and fees for right to use IPR i.e., royalty. Therefore the TPO in his order cannot say that no benefit or services were received by the Assessee from FHPL and FIPL. To this extent the orders of assessment in the case of FHPL and FIPL would be relevant and will go to show that the Assessee received benefit or service from FHPL and FIPL for which it made payments to FHPL and FIPL.
Apart from the conclusion that the Assessee received services from FHPL and FIPL for which it made payments from the orders of
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assessment in the case of FHPL and FIPL, we also find that the Hon'ble Delhi High Court in the case of CIT v. EKL Appliances Ltd., ITA No.1068/2011 dated 29.03.2012 had taken the view that the TPO has to evaluate the ALP of an international transaction and without doing so, he cannot give a finding that the Assessee received no services and therefore the ALP has to be determined at NIL. The Hon’ble Delhi High Court had to deal with a case where an assessee entered into an agreement pursuant to which it paid brand fee/ royalty to an associated enterprise. The TPO disallowed the payment on the ground that as the assessee was regularly incurring huge losses, the know-how/ brand had not benefited the assessee and so the payment was not justified. This was reversed by the CIT (A) & Tribunal on the ground that as the payment was genuine, the TPO could not question commercial expediency. On appeal by the department, the Hon'ble Delhi High Court held that the "transfer pricing guidelines" laid down by the OECD make it clear that barring exceptional cases, the tax administration cannot disregard the actual transaction or substitute other transactions for them and the examination of a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises. The guidelines discourage re-structuring of legitimate business transactions except where (i) the economic substance of a transaction differs from its form and (ii) the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been
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adopted by independent enterprises behaving in a commercially rational manner. The OECD guidelines should be taken as a valid input in judging the action of the TPO because, in a different form, they have been recognized in India's tax jurisprudence. It is well settled that the revenue cannot 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 (Eastern Investment Ltd 20 ITR 1 (SC), Walchand & Co 65 ITR 381 (SC) followed). Even Rule 10B(1)(a) does not authorise disallowance of expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same.
The Hon’ble Delhi High Court in the case of Cushman & Wakefield India Private Limited ITA No.475/2012 dated 23.5.2014 367ITR 730 (Del), observed that whether a third party – in an uncontrolled transaction with the Taxpayer would have charged amounts lower, equal to or greater than the amounts claimed by the AEs, has to perforce be tested under the various methods prescribed under the Indian TP provisions. In the context of cost sharing arrangement, the Hon’ble High Court opined that concept of base erosion is not a logical inference from the fact that the AEs have only asked for reimbursement of cost. This being a transaction between related parties, whether that cost itself is inflated or not only is a matter to be tested under a comprehensive transfer pricing analysis. The basis for the costs incurred, the activities for which they were
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incurred, and the benefit accruing to the Taxpayer from those activities must all be proved to determine first, whether, and how much, of such expenditure was for the purpose of benefit of the Taxpayer, and secondly, whether that amount meets ALP criterion. In the present case however, the arrangement between the AE and the Assessee is not a cost sharing arrangement but a payment for specific services rendered. To this extent the above observations of the Hon’ble High Court may not be relevant to the present case. The Hon’ble Delhi High Court held that the following aspects would require consideration in order to identify intra group services requiring arm’s length remuneration: * Whether services were received from related party. * Nature of services including quantum of services received by the related party. * Services were provided in order to meet specific need of recipient of the services. * The economic and commercial benefits derived by the recipient of intra group services. * In comparable circumstances an independent enterprise would be willing to pay the price for such services? * An independent third party would be willing and able to provide such services?
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Whether payment made to AE meets ALP criterion will be determined, keeping in mind all the above factors, as well. 23. The learned counsel placed reliance on the decision of the ITAT Bangalore in the case of UAE Development India Pvt.Ltd. (supra). This decision was rendered prior to the decision of the Hon’ble Delhi High Court in the case of Cushman & Weikfield (supra). The special Bench ITAT, Kolkata in the case of Instrumentarium Corporation Ltd. Vs. ADIT I.T.A. Nos.1548 and 1549/Kol/2009 for Assessment years: 2003-04 and 2004-05 in its order dated 15.7.2016 had to deal with somewhat similar issue. The background in which this question has come up for the consideration before the special bench was that the Assessee Instrumentarium Corporation Limited (ICL-Finland, in short), was a company incorporated in, and tax resident of, Finland. The assessee was engaged in the business of manufacturing and selling medical equipment, and it has a wholly owned subsidiary in India by the name of Datex Ohmeda India Pvt Ltd (Datex India, in short) which acted as ICL-Finland's marketing arm for its products in India. On 26th August 2002, the assessee entered into an agreement, which was duly approved by the Reserve Bank of India, to advance an interest free loan of Rs 36 crores to Datex-India. The interest free advance by the assessee to its Indian subsidiary which is the subject matter of dispute before the Special bench. The precise point of dispute was if the Assessing Officer adopts arm's length interest on the loan, an arm's length price (ALP) adjustment is required to be
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made to the income to be brought to tax in the hands of the assessee, i.e. ICL-Finland. Corresponding the Indian entity should be allowed the deduction of interest expense. The tax inflow in India on interest income in the hands of ICL-Finland would be just 10% of the ALP interest while the corresponding expense if allowed in the hands of the Indian entity, there would be a benefit of 30% if the ALP interest to the Indian entity. In this scenario whether the exercise of determination of ALP would serve any purpose, was the question before the Special Bench. The plea of the assessee was that there was no erosion of Indian tax base and therefore no such adjustment can be made. The special Bench ruled against the Assessee and held that in order to further the objective of preventing base erosion, the substantive section of the Indian TP code, i.e., section 92(1) of the Act, requires that any income arising from an international transaction shall be computed having regard to the ALP. Further, as per Rule 10D of the Income-tax Rules, 1962, ALP is required to be contemporaneously determined by an assessee. From a conjoint reading of CBDT circular No. 14 of 2001, section 92(1) and Rule 10D, contemporaneous determination of ALP would need to be undertaken by an assessee, and such determination cannot be bereft of the underlying intent of prevention of base erosion in India.
Section92(1) of the Act lays down that any income arising from an international transaction shall be computed having regard to the arm’s length price. Section 92B(1) of the Act defines “international
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transaction” and it lays down that for the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. Section-92C(1) of the Act lays down that the arm’s length price in relation to an international transaction shall be determined by any one of the most appropriate methods set out in that section, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe. When the AO makes a reference to the TPO for determination of ALP, the provisions of Sec.92CA(2) & (3) of the Act makes it mandatory for the TPO to determine ALP of international transaction, whether it is referred to by the AO or any other transaction which comes to his notice. These provisions read thus: “(2) Where a reference is made under sub-section (1), the Transfer Pricing Officer shall serve a notice on the assessee requiring him to produce or cause to be produced on a date to be specified therein, any evidence
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on which the assessee may rely in support of the computation made by him of the arm’s length price in relation to the international transaction referred to in sub- section (1).
(3) On the date specified in the notice under sub-section (2), or as soon thereafter as may be, after hearing such evidence as the assessee may produce, including any information or documents referred to in sub-section (3) of section 92D and after considering such evidence as the Transfer Pricing Officer may require on any specified points and after taking into account all relevant materials which he has gathered, the Transfer Pricing Officer shall, by order in writing, determine the arm’s length price in relation to the international transaction in accordance with sub-section (3) of section 92C and send a copy of his order to the Assessing Officer and to the assessee.”
Once, the TPO determines ALP, the AO has no other option but to make addition to the total income of an Assessee as TP adjustment by the TPO. This would be clear from the provisions of Section 92CA(4) of the Act. Sec.92CA(4) of the Act, as it stood prior to amendment by the Finance Act, 2007 read as follows:- “92CA (4) On receipt of the order under sub-section (3), the Assessing Officer shall proceed to compute the total income of the assessee under sub-section (4) of section 92C having regard to the arm's length price determined under sub-section (3) by the Transfer Pricing Officer.” The AO on receipt of a report from the TPO had power to disregard to the ALP determined by the TPO. However with effect from 1st June, 2007, Section 92CA(4) has undergone a change vide Section 33 of the
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Finance Act, 2007 whereby it has been laid down that the Assessing officer is bound to pass an order in conformity with the ALP determined by the TPO. Amended Section 92CA(4) reads as under:— "92CA(4) On receipt of the order under sub-section (3), the Assessing Officer shall proceed to compute the total income of the assessee under sub-section (4) of section 92C in conformity with the arm's length price as so determined by the Transfer Pricing Officer. (Emphasis supplied)
The provisos to Sec.92CA(4) of the Act read thus: “Provided that no deduction under section 10A or section 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section :
Provided further that where the total income of an associated enterprise is computed under this sub-section on determination of the arm’s length price paid to another associated enterprise from which tax has been deducted or was deductible under the provisions of Chapter XVIIB, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm’s length price in the case of the first mentioned enterprise.”
The CBDT in it’s Circular No. No.14/2001 dated 9.11.2001 has explained the purport of the 2nd proviso to Sec.92C(4) of the Act as follows:
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“55.13 The second proviso to section 92C(4) refers to a case where the amount involved in the international transaction has already been remitted abroad after deducting tax at source and subsequently, in the assessment of the resident payer, an adjustment is made to the transfer price involved and, thereby, the expenditure represented by the amount so remitted is partly disallowed. Under the Income-tax Act, a non- resident in receipt of income from which tax has been deducted at source has the option of filing a return of income in respect of the relevant income. In such cases, a non-resident could claim a refund of a part of the tax deducted at source, on the ground that an arm’s length price has been adopted by the Assessing Officer in the case of the resident and the same price should be considered in determining the taxable income of the non- resident. However, the adoption of the arm’s length price in such cases does not alter the commercial reality that the entire amount claimed earlier would have actually been received by the entity located abroad. It has therefore been made clear in the second proviso that income of one associated enterprise shall not be recomputed merely by reason of an adjustment made in the case of the other associated enterprise on determination of arm’s length price by the Assessing Officer.”.
It is clear from the above circular that second proviso to Sec.94CA(4) is meant to apply only when ALP is determined in the case of FIPL and FHPL. Another aspect which the Circular makes it clear is that the commercial reality of a transaction will be looked into viz., wherever the determination of income or expense in the hands of one enterprise results in tax base erosion of the country, the AO is free to apply the provisions of Sec.92(1) read with Sec.92CA(4).
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Corresponding adjustment in the assessment of the other enterprise to the transaction need not be made where there is no tax base erosion of the country. This is also the purport of Sec.92(3) of the Act which lays down that wherever computation of income under sub-section (1) of Sec.92 or the determination of the allowance for any expense or interest under that sub-section, or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2) of Sec.92, has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into. There would appear to be a conflict between the provisions of Sec.92CA(4) and Sec.92(3) but a harmonious construction of these provisions would be hold that in respect of a same transaction the revenue can opt to determine total income on the basis of ALP determined in accordance with Sec.92(1) of the Act, in the hands of one party to the said transaction, wherever tax base of the country would erode. The revenue can desist from doing so in the assessment of the other party to the said transaction wherever there would not be tax base erosion. It cannot therefore be said that consequent to acceptance of return of income filed by FHPL and FIPL, the price paid by the Assessee in the international transaction has to be accepted as at Arm’s Length.
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In the light of the above discussion and the decisions on the issue rendered after the decision in the case of UAE Development India Pvt.Ltd. (supra), we are of the view that ALP has to determined in the hands of the Assessee irrespective of the acceptance of ALP in the hands of FHPL and FIPL. The question as to whether the payment for such services are at Arm’s Length or commensurate with the benefit received by the Assessee are all matters which needs examination by the TPO. No such exercise has been carried out by the TPO. But that does not mean that the ALP has been established by the Assessee. We are therefore of the view that it would be just and proper to set aside the order of the Assessing Officer on this issue and remand the question of determination of ALP to the TPO for fresh consideration. It is made clear that the TPO shall not dispute that services were rendered by the AE. If the approach of the Assessee in adopting TNMM at entity level is disputed by the TPO, the Assessee should be permitted to file TP study for each of the international transaction separately. The assessee is also directed to file the TP study, if not already filed which is in accordance with the provisions of the Act and substantiate that the price paid by it to its AE is at arm's length within the methods laid down in the Act and the judicial decisions rendered on this issue. The TPO will consider the same in accordance with the law, after affording an opportunity of being heard.
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As far as other grounds raised by the Assessee in its appeal are concerned, Ground No.1 raised by the Assessee is general. Gr.No.10 & 11 regarding charging of interest u/s.234B and 234C are consequential. These grounds need no specific adjudication. Gr.No.9 raised by the Assessee is unsustainable in view of the statutory amendment to Sec.92C(2) proviso. Gr.No.2 with regard to invalid reference to the TPO was not pressed and the same is dismissed as not pressed. Gr.No.3 with regard to the invalidity of the order of assessment making addition on account of adjustment in ALP suggested by TPO on the ground that TPO did not confront to the Assessee information received from IRA, Singapore, has already been dealt with while deciding Gr.No.8. Gr.No. 4 to 7 are with regard to merits of the addition made by the AO. As far as these grounds are concerned, we find that the Assessee has filed evidence to show services rendered by AE and use of IPR of AE. These are annexure 2 to 14 of the paper book filed by the Assessee and are at pages 370 to 504. Some additional evidence was also filed by the Assessee before DRP and these are annexure-2 to 5 of evidence filed before DRP and are at pages 513 to 651 of the Assessee’s paper book. As we have already held, the TPO misdirected himself by not examining these evidence on the premise that the payment to the AE’s was only with a view to reduce tax liability in India and to shift profits earned in India out of India. The tests laid down in the judicial decision referred to in the earlier part of this order have to be applied to the evidence filed by the Assessee. Since this exercise has not been carried out, we have
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remanded the issue to the TPO for fresh consideration. The learned counsel for the Assessee vehemently argued that the revenue should not be given a second innings. We are of the view that there cannot be any estoppels in cases involving Transfer Pricing. These are new provisions and are evolving. The ITAT special bench in the case of Quark Systems Pvt.Ltd., (2010) 38 SOT 307 (Chd.)(SB) has held that there cannot be estoppel in Transfer Pricing issues and the law on the subject was evolving and it would not be unfair to hold that an Assessee can take a stand that a company chosen by it as comparable is in fact not comparable. Keeping in mind the decision of the Special Bench referred to above, we are of the view that the determination of ALP is an exercise which has to be carried out by the TPO in accordance with the provisions of the Act. Though at the time of hearing arguments were addressed more on Gr.No.2, 3 and 8, We are of the view that since the TPO and the DRP have not examined the case in the manner they were required to do and since this exercise is a must, no useful purpose will be served by addressing on the merits of the other grounds of appeal.
In the result, appeal by the Assessee is treated as allowed for statistical purpose. Order pronounced in the open court on 11th April, 2018.
Sd/- Sd/- (JASON P BOAZ) (N.V VASUDEVAN) ACCOUNTANT MEMBER JUDICIAL MEMBER
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Bangalore Dated : 11/4/2018 Vms
Copy to :1. The Assessee 2. The Revenue 3.The CIT concerned. 4.The CIT(A) concerned. 5.DR 6.GF By order
Sr. Private Secretary, ITAT, Bangalore