DCIT, NEW DELHI vs. M/S. CORNELL OVERSEAS (P) LTD., NEW DELHI

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH ‘I-1’, NEW DELHI Before Sh. N. K. Saini, AM and Smt. Beena Pillai, JM ITA No. 2166/Del/2011 : Asstt. Year : 2003-04 DCIT, Vs Cornell Overseas (P) Ltd., Circle-3(1), B-235, Okhla Indl. Area, Phase-I, New Delhi New Delhi-110020 (APPELLANT) (RESPONDENT) PAN No. AAACC0034F Assessee by : Ms. Vandana Bhandari, CA Revenue by : Sh. Neeraj Kumar, Sr. DR Date of Hearing : 03.02.2017 Date of Pronouncement : 02.05.2017 ORDER Per N. K. Saini, AM: This is an appeal by the department against the order dated 28.02.2011 of ld. CIT(A)-XX, New Delhi.

ITA No. 2166/Del/2011 2 Cornell Overseas (P) Ltd. 2. The Ld. CIT(A) has erred on facts and in law in directing the AO not to exclude the Sample Design and Development charges receipt amounting to Rs.96,13,655/- for the calculation of deduction u/s 80HHC ignoring that the assessee failed to file documentary evidence to justify its claim and as per provisions of explanation (baa) of section 80HHC, for computing "profits of business" 90% of sums referred to in clauses (iiia) to (iiie) of section 28 or any receipt by way of brokerage, commission, interest, rent, charges of any receipt of similar nature included in such profits have to be deducted from the profits and gains of business or profession. Reliance is also placed on the decision of Hon'ble ITAT in Beekay Engineering & Casting Ltd. vs. JCIT A. No. 4961(Del) of 2002. 3. The Ld. CIT(A) has erred on facts and in law in directing the AO to allow the claim of the assessee on account of additional depreciation amounting to Rs.20,61,050/- ignoring that documentary evidence in support of the asessee's claim for additional depreciation u/s 32(iia) of the I.T. Act is not available on record. Further, the assessee also failed to file the audit report even before the completion of the assessment. 4. The Ld. CIT(A) has erred on facts and in law in deleting addition of Rs.1,57,35,495/- on account of Arm's Length Price u/s 90CA(3) ignoring the fact that each international transaction must be benchmarked separately. The approach of amalgamating transactions should be followed only where the transaction are closely interlinked. The TPO has brought out that in the assessee's

ITA No. 2166/Del/2011 3 Cornell Overseas (P) Ltd. arrangement with its AE, the rewards of the marketing and fruits of intangible would be enjoyed by the AE. Hence, the assessee need not make a payment for the same. Ld. CIT(A) has erred in ignoring this fact. 5. The appellant craves leave for reserving the right to amend, modify, alter, add or forego any grounds of appeal at any time.” 3. Vide Ground No. 1, the grievance of the department relates to the inclusion of the DEPB receipt amounting to Rs.1,27,73,524/- for calculation of deduction u/s 80HHC of the Income-tax Act, 1961 (hereinafter referred to as ‘the Act’).

ITA No. 2166/Del/2011 4 Cornell Overseas (P) Ltd. prove with necessary and sufficient evidence that rate of duty Drawback was higher than the rate of DEPB but still the assessee opted for DEPB in order that the DEPB amount qualified for inclusion in the amount specified in proviso to Sub-section (3). The AO observed that since the assessee failed to furnish any such evidence, the amount of DEPB of Rs.1,27,73,524/- shall not be included in 90% of the amount to be added to profits of business.

ITA No. 2166/Del/2011 5 Cornell Overseas (P) Ltd. 6. The ld. CIT(A) after considering the submissions of the assessee decided the issue in favour of the assessee by stating that the similar issue was decided in assessee’s favour for the assessment year 2002-03.

ITA No. 2166/Del/2011 6 Cornell Overseas (P) Ltd. 1,27,73,524/- on account of DEPB. Hence, this matter should be remanded back to the AO to examine the profit element in the sale of DEPB License and to re-compute the deduction u/s 80HHC in light of the judgement of Hon'ble Supreme Court in case of Topman Exports 342 ITR 49 (SC).” 8. In her rival submissions the ld. Counsel for the assessee strongly supported the orders of the authorities below and further submitted that an identical issue has been decided by the ITAT for the assessment year 2002-03 in assessee’s own case and the issue is now covered in assessee’s favour by the decision of the Hon’ble Supreme Court in the case of Topman Exports reported at (2012) 18 Taxman 120.

ITA No. 2166/Del/2011 7 Cornell Overseas (P) Ltd. export made and that the profits of duty entitlement passbook representing the excess of sale proceeds over the face value is liable to be considered u/s 28(iiid) at the time of sales.” 7.1 Undisputedly, ITAT Mumbai Bench (SB) in case of Topman Exports Vs ITO (2009) 33 SOT 337 answered the aforesaid question in favour of the assessee by returning the following findings: “We, therefore, hold that in the scheme of section 80HHC, the face value of DEPB cannot be reduced from the purchase cost but is separate income under section 28(iiib), which accrues at the time of making application pursuant to exports. Only the profit element on the sale of DEPB, that is the amount in excess of sale proceeds over the face value, is covered under section 28(iiid).” 7.2 Then the matter went to Hon’ble Apex Court in the case entitled Topman Exports Vs CIT (2012) 18 Taxman 120 (S.C.). Hon’ble Apex Court upheld the order passed by Special Bench of the Tribunal (Mumbai) and the crux of the findings returned is as under for ready reference: “The aforesaid discussion would show that where an assessee has an export turnover exceeding Rs. 10 crores and has made profits on transfer of DEPB under. clause (iiid) of section 28, he would not get the benefit of addition to export profits under third or fourth proviso to sub-section (3) of section 80HHC but he would get the benefit of exclusion of a smaller figure from 'profits of the business' under Explanation (baa) to section 80HHC and there is

ITA No. 2166/Del/2011 8 Cornell Overseas (P) Ltd. nothing in Explanation (baa) to section 80HFic to show that this benefit of exclusion of a smaller figure from 'profits of the business' will not be available to an assessee having an export turnover exceeding Rs. 10 crores in other words, where the export turnover of an assessee exceeds Rs. 10 crores, he does not get the benefit of addition of ninety per cent of export incentive under clause (iiid) of section 28 to his export profits, but he gets a higher figure of profits of the business, which ultimately results in computation of a bigger export profit. The High Court, therefore, was not right in coming to the conclusion that as the assessee did not have the export turnover exceeding Rs. 10 crores and as the assessee did not fulfill the conditions set out in the third proviso to section 80HHC (iii), the assessee was not entitled to a deduction under section 80HHC on the amount received on transfer of DEPB and with a view to get over this difficulty the assessee was contending that the profits on transfer of DEPB under section 28 (iiid) would not include the face value of the DEP B. It is a well-settled principle of statutory interpretation of a taxing statute that a subject will be liable to tax and will be entitled to exemption from tax according to the strict language of the taxing statute and if as per the words used in Explanation (baa) to section 80HHC read with the words used in clauses (iiid ) and (iiie) of section 28 the assessee was entitled to a deduction under section 80HHC on export profits, the benefit of such deduction cannot be denied to the assessee. [Para 22] The impugned judgment and orders of the High Court are accordingly, set aside. The appeals are allowed to the extent indicated in this judgment. The

ITA No. 2166/Del/2011 9 Cornell Overseas (P) Ltd. Assessing Officer is directed to compute the deduction under section 80HHC in the case of the assessee in accordance with this judgment.” 7.3 Now, adverting to the facts of the case at hand, undisputedly, the assessee company has credited an amount of Rs.1,13,99,395/- received on account of DEPB in the year under consideration. Assessing Officer returned the findings that since the assessee has failed to furnish any evidence that “rate of duty drawback was higher than the rate of DEPB”, the amount of DEPB shall not be included in 90% of the amount to be added to the profits of business and thereby 90% of the DEPB amount i.e. Rs.1,02,59,456/-0 was reduced from computation of profits of business for the purpose of calculating the deduction u/s 80HHC. Consequently, Assessing Officer reduced the deduction u/s 80HHC from Rs.3,03,36,393/- to Rs.2,31,60,167/-. 7.4 Undisputedly, in case, turnover of the assessee is up to Rs.10 crores, the assessee will get deduction of 90% of the amount to be added to profits of business of export incentive and consequent deduction u/s 80HHC(3). It is also not disputed that the assessee has failed to furnish the requisite evidence to prove that he rate of duty drawback was higher than the rate of DEPB. 7.5 However, Ld. A.R. contended that the assessee has claimed the addition under 3rd proviso to Section 80HHC(3) at Rs.6,61,653/- i.e. 90% of Rs.7,35,170/-. Ld. A.R. further contended that 3rd and 4th proviso to section 80HHC(3)(c) operate only prospectively and relied upon the judgement cited as Pawan Kumar

ITA No. 2166/Del/2011 10 Cornell Overseas (P) Ltd. Jain VSs Union of India (2014) 46 Taxmann.com 341 (Del.). 7.6 The Assessing Officer denied the benefits claimed by the assessee by invoking provisions under Section 80HHC and Section 28(iiid) w.r.e.f Assessment Year 1998-99 with retrospective effect according to which any profits on transfer of DEPB scheme deem duty addition scheme under export and import policy shall be charged under the head ‘profits & gains from the business or profession’ with further consideration that as per 3rd proviso to Section 80HHC, assessee having export turnover up to Rs.10 crores will get deduction of 90% of export incentive on account of transfer of profits on account of DEPB license. However, the assessee having export turnover exceeding 10 crores will get this deduction only on bringing on record sufficient evidence to prove that he had an option to chose either the duty drawback or DEPB scheme and the duty free replenishment certificate regarding rate of drawback credit attributable to the custom duty was higher than the rate of credit allowable under DEPB scheme and the duty free payment scheme. 7.7 So, by applying the provisions contained u/s 80HHC 3rd proviso read with section 80(iiid) retrospectively, the Assessing Officer reduced 90% of DEPB amount of Rs.1,02,59,456/- to Rs.2,31,60,167 instead of Rs.3,03,63,393/- as claimed by the assessee. Following the law laid down by Hon’ble Apex Court in the judgement cited as Topman Exports (supra) and the Hon'ble Jurisdictional High Court in the case cited as Pawan Kumar Vs Union of India (supra), proviso 2nd, 3rd and 4th to Section

ITA No. 2166/Del/2011 11 Cornell Overseas (P) Ltd. 80HHC (3)(c) is to be made applicable only prospectively and not retrospectively. So, the assessee in this case is entitled to deduction u/s 80HHC without bringing on record the evidence as required by the Assessing Officer. So, we find no infirmity in the findings returned by Ld. CIT(A). Hence, Ground No.1 is returned against the Revenue.” 10. So, respectfully following the aforesaid referred to order dated 30.03.2016 in ITA No.4739/Del/2010, the issue stands covered in favour of the assessee.

ITA No. 2166/Del/2011 12 Cornell Overseas (P) Ltd. Act by observing in para 3.2.5 of the assessment order dated 28.03.2006 which read as under: “3.2.5. Sample Design & Development Charges Received – The assessee has shown receipts of Rs.96,13,655/- on account of sample design and development charges. The assessee was asked to show cause as to why the same be not excluded from the computation of deduction. No reply has been filed in this regard, it may be pertinent to refer to the assessment and appellate proceedings in the case of the assessee for A.Y. 2001-02 in order to arrive at a conclusion regarding the treatment of these receipts. During the aforesaid proceedings it was stated by the assessee that the consideration on account of such sales did not have an element of profit, being in the nature of reimbursement of expenses. Also as per the provisions of explanation (baa) of section 80HHC, for computing profits of business", 90% of sums referred to in clauses (iiia) to (iiie) of section 28 or of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits have to be deducted from profits and gains of business or profession. I therefore hold the receipts of Rs. 96,13,655/- as receipts of similar nature included in "such profits" referred to in explanation (baa), in this regard, reliance is placed on the decision of Hon’ble ITAT, Delhi in the case of Beekay Engineering & Castings Ltd. Vs Joint Commissioner of income Tax in IT Appeal No. 4961 (Delhi) of 2000 dated 22.07.2004 wherein the assessee in that case had incurred expenses and in that process recovered same also, it was held that such incomes are in

ITA No. 2166/Del/2011 13 Cornell Overseas (P) Ltd. principle excludible to the extent of 90% out of profits of business in terms of explanation (baa).” 13. Being aggrieved the assessee carried the matter to the ld. CIT(A) and submitted as under: “AO has wrongly treated the reimbursement of Sample Design and Development Charges from overseas customers amounting to Rs 96,13,655/- as 'other receipt' under clause 1 to explanation (baa) of Section 80HHC, whereas it is out-and-out export turnover and hence represent business income of the appellant. The amount represents receipts towards sale of sample designs to overseas customers which has the matching debit in profit & loss account under various heads of expenditures, incurred on development of these sample designs; the net effect of above debit and credit entries in the profit & loss account of the appellant is zero. Explanation (baa) to Section 80HHC reads as under: "Profits of the business" means the profits of the business as computed under the head "Profits and gains of business or profession as reduced by- (1) Ninety per cent of any sum referred to in clauses (iiia), (iiib) (iiic), (iiid) and (iiie) of section 28 or of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits; and The object of inserting clause (baa) has been explained in the circular No. 621 dated 19-12-1991

ITA No. 2166/Del/2011 14 Cornell Overseas (P) Ltd. issued by the C.B.D.T. The relevant portion of the said circular in paragraphs 32.10 and 32.11 read as follows: "32.10 The existing formula often gives a distorted figure of export profits when receipts like interest, commission, etc. which do not have element of turnover are included in the profit and loss account. 32.11 It has, therefore, been clarified that "profits of the business" for the purpose of section 80HHC will not include receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature. As some expenditure might be incurred in earning these incomes, which in the generality of cases is part of common expenses, ad hoc 10 per cent deduction from such income is provided to account for these expenses." (emphasis supplied) Therefore it is amply clear from para 32.10 of the circular that the purpose of excluding receipts like interest, Commission, other receipt etc. from the ambit of the profits of the business is to exclude such receipts which do not have an element of turnover. Whereas in the case of appellant the development of sample designs is core business activity regularly carried on by the appellant; the proceeds from the export of sample designs satisfy the test of 'Export Turnover' laid down in clause (b) to Explanation to Section 80HHC. Further the proceeds from export of sample designs have been upheld to be 'Export Turnover' by the Hon'ble ITAT in the case of assesses during AY 01-02 (copy of the

ITA No. 2166/Del/2011 15 Cornell Overseas (P) Ltd. order of ITAT is enclosed for your reference Attachment 3). It may also be noted that amounts received from overseas customers towards 'Sample design and Development 'is export turnover it is also evident from the fact that the appellant has received Duty Drawback on the same. Therefore, one cannot say that the export of sample designs by the appellant is not an integral part of the business carried on by the appellant. Hence the profits reported by the appellant under the head Profits and Gains from Business including sale proceeds of sample designs forms part of operating profits of the company and not 'other receipt' as misconceived by AO. As explained in the Board Circular, what is not included in the profits of the business for the purpose of section 80HHC are receipts by way of brokerage, commission, rent, interest or any other receipt of a similar nature. Such receipts do not have any corresponding expenditure to be incurred. It is for that purpose an ad hoc deduction of 10 per cent is given for some probable expenditure that might be incurred to earn such different types of receipts. But in the case of the appellant, these sample design and development charges are not earned at a nominal cost of 10 per cent of such receipts. The appellant is receiving such charges by utilising the entire factory and production system. Such charges are earned by the appellant after incurring matching expenditure of Rs 96,13,655/- in the form of raw material, wages, energy, rent, rates,

ITA No. 2166/Del/2011 16 Cornell Overseas (P) Ltd. depreciation, debited under various heads of expenses in profit & loss account. The word "other receipt" used in sub-clause (i) of clause (baa) is found in the company of expressions like "brokerage", "commission", "interest", "rent". Applying the principle of "ejusdem generis", the term "Other Receipt" has to be read in the company of the preceding words, such as brokerage, commission, interest, rent, etc. The brokerage or commission or interest, or rent does not have any nexus with any manufacturing or core business activity that could be carried on by the assessee. Similarly, the word "Other Receipt" appearing in the company of those words also will not have any nexus with manufacturing or processing or core business activity of an assessee. The word "Other Receipt" appearing in the company of brokerage, commission, interest, rent etc. cannot be singled out and assigned a different meaning alleging a nexus with manufacturing or processing or core business activities. Therefore, the word "Other Receipt" appearing in clause (baa) of Explanation to section 80HHC should be read as receipts similar to receipts in the nature of brokerage, commission, interest, rent, etc.” 14. The reliance was placed on the following case laws: � CIT Vs Bangalore Clothing Co. (2003) 127 Taxman 637 (Bom) � CIT, Coimbatore Vs Kiran Processors (2007) 158 Taxman 407 � ITO-3(3)(3) Vs Su-raj Jewellery (India) Ltd. (2008) 21 SOT 79 (Mum. ITAT)

ITA No. 2166/Del/2011 17 Cornell Overseas (P) Ltd. � ACIT Vs Herbal Isolates (P) Ltd. (2002) 83 ITD 310 (Cochin) 15. The ld. CIT(A) after considering the submissions of the assessee held that the reimbursement of sample design and development charges constitute export turnover of the business and hence represent business income of the assessee, the same could not be included as other receipt under Explanation (baa) to Section 80HHC of the Act.

ITA No. 2166/Del/2011 18 Cornell Overseas (P) Ltd. own case. It was also stated that the issue is also covered in favour of the assessee by the Circular No. 621 dated 19.12.1991 issued by the CBDT.

ITA No. 2166/Del/2011 19 Cornell Overseas (P) Ltd. would appear to have contended that no element of profit is involved in the receipt but the contention was rejected for lack of evidence and the CIT (Appeals), relying on the definition of total turnover, upheld the Assessing Officer’s action. We have carefully considered the matter. The receipt arose out of sale of samples exported out of India to the customers. The sale proceeds were received in foreign currency. The plea that the receipt was in the nature of reimbursement of expenses and did not include an element of profit has not been accepted by the CIT (Appeals) for lack of evidence and the position remains the same even before us. We are, therefore, of the view that no fault can be found with the income-tax authorities when they included the receipt of Rs.10,66,725/- in the total turnover of the business. As regards the alternative claim for including the receipt as part of the export turnover, which is the numerator in the formula prescribed by the section, it cannot be said that the assessee exported samples, since sending samples is a means to procure export orders. The same goes for the design and sample charges. However, since the assessee has not been able to prove that there is no profit element imbedded in the receipt and we have on the ground held that the receipt is includible as part of the total turnover, it will be inconsistent to hold that the receipt cannot be included in the export turnover. For this reason – for the sake of consistency alone – it is held that the alternative claim of the assessee can be allowed. We hold accordingly and direct the Assessing Officer to recompute the deduction. Thus ground No.5 is rejected, but Ground No.6 is allowed.”

ITA No. 2166/Del/2011 20 Cornell Overseas (P) Ltd. 19. So, respectfully following the aforesaid referred to order of the ITAT, we do not see any infirmity in the order of the ld. CIT(A) who rightly held that the receipts on account of sample design and development charges are export turnover and represents the business income of the assessee and thus, cannot be excluded as the receipt under Explanation (baa) of Section 80HHC of the Act.

ITA No. 2166/Del/2011 21 Cornell Overseas (P) Ltd. AO has not provided the appellant sufficient opportunity to explain the claim of additional depreciation nor did he provide the opportunity to file form 3AA which was inadvertently not filed along with the return of income. This is evident from para 6.1 of the assessment order wherein AO seemed to be not even aware of the fact that assessee has claimed additional depreciation under Clause A of first proviso to section 32(1)(iia) (being additional depreciation available to new industrial undertaking) whereas throughout in the assessment order he refuted the claim of the assessee under Clause B of first proviso to Section 32(1)(iia) (being additional depreciation available on achieving substantial expansion by way of increase in installed capacity). One of the arguments put forward by AO for denial of additional depreciation is that perusal of Schedule 19 to the balance sheet containing significant accounting policies and notes to accounts shows that quantitative and other information regarding goods manufactured, licensed capacity and installed capacity are mentioned as N.A therefore the increase in installed capacity remained unsubstantiated. In this context kindly note that final products in appellant's industry are extremely diverse and dynamic and therefore it is not practicable to provide the details of licensed and installed capacity. Therefore AO has grossly erred in law in arbitrarily concluding that appellant is not eligible for additional depreciation without going into the facts of the case. It is therefore preyed to kindly admit Form 3AA as an additional evidence for claim of additional

ITA No. 2166/Del/2011 22 Cornell Overseas (P) Ltd. depreciation u/s 32(l)(iia) filed with your goodself vide letter dt. 26.10.2006.” 23. Reliance was placed on the following case laws: � CIT Vs Maganum Exports P. Ltd. (2003) 262 ITR 10 (Cal.) � CIT Vs Jayant Patel (2001) 117 Taxman 707 (Mad.) � CIT Vs Shahzadanand Charity Trust (1998) 96 Taxman 494 (P&H) � CIT Vs Hardeodas Agarwalla Trust (1992) 198 ITR 511 (P&H) 24. The ld. CIT(A) after considering the submissions of the assessee asked the remand report from the AO and after considering the submissions of the assessee and the remand report of the AO, observed that the assessee had inadvertently not filed the evidence to claim additional depreciation u/s 32(iia) of the Act alongwith the return of income. He, therefore, accepted the addition evidence during the appellate proceedings and directed the AO to inquire the claim of the assessee and made necessary modification, if any.

ITA No. 2166/Del/2011 23 Cornell Overseas (P) Ltd. course of assessment proceedings and not during the appellate proceedings.

ITA No. 2166/Del/2011 24 Cornell Overseas (P) Ltd. claim of the assessee and allow after verification. We do not see any valid ground to interfere with the findings of the ld. CIT(A).

ITA No. 2166/Del/2011 25 Cornell Overseas (P) Ltd. 30. The TPO noticed that the assessee had undertaken following international transactions with its groups companies: S.No. Description of transaction Method Value (in Rs.) 1 Garments made ups CPM 35,10,62,665 2 Receipts Charges for TNMM 95,80,428 samples provided for various styles 3 Payment of royalty CUP 1,57,35,495

The assessee benchmarked its major international transaction of sale of garments using cost plus method and had earned gross profit of 19% as calculated in Annexure B of Transfer Pricing Report whereas the comparables had earned 12% to 16% as per Annexure C of Transfer Pricing Report. The assessee treated the transaction at Arm’s Length Price on the basis that it had earned better net margins as compared to the comparables. The TPO noticed that during the relevant year PRC had entered into an agreement with the assessee for licensing its designs and as per the agreement, the assessee will be entitled to the following: “a) to manufacture, distribute or sell products from designs created by PRC. b) to manufacture, distribute or sell products reproduced from designs prepared by the assessee company and approved by PRC.

ITA No. 2166/Del/2011 26 Cornell Overseas (P) Ltd. c) to use of PRC’s know-how and designs in connection with the manufacture and sale of products.” 31. The TPO also observed that the assessee had paid royalty @ 5% of sales of products made during the year and the benefits arising out of this agreement as submitted in reply dated 22.02.2006 had been enumerated by the assessee company as supply of design, use of logo, visit of the PRC personnel for providing guidelines and expertise, access to the market, and finally use of technical know-how provided by PRC to the assessee company. The TPO observed that the assessee had sales to its associated enterprises (A.E.) as per following details: A. Sale of garments Cornell USA 27,11,07,996 Cornell Canada 7,69,00,027 Other group companies 1,26,35,070 Total sales (X) 36,06,43,093 B. Sale of samples Cornell USA 43,26,759 Cornell Canada 52,53,669 Total (Y) 95,80,428 X+Y 37,02,23,521

ITA No. 2166/Del/2011 27 Cornell Overseas (P) Ltd. to be employed, the place at which logo was to be fixed and the mode of delivery was determined by the AE who was having common control through Cornell Shareholder exercising full control over the affairs of the assessee. The TPO, therefore, inferred that the assessee company was a mere contract manufacturer of its overseas related party and the risk & reward matrix in respect of contract manufacturer was entirely different from an independent entrepreneur who may require technical know-how, logo, market access, designs and help of an expert whereas the contract manufacturer required none out of the above. He further observed that the contract manufacturer, did not carry the risk of marketing and therefore was not worried about the latest trends in the market, this risk was borne by the entity providing work to the contract manufacturer who necessarily carries the manufacturing risks like decline in production, maintenance of quality, timely delivery etc. and in the present case, when the assessee company was performing functions of the contract manufacturer, it was very difficult to understand why there were payments for intangibles like royalty and technical know- how in the nature of designs provided by the associated enterprises. The TPO also observed that the designs and its production technology was being provided by the AE to ensure

ITA No. 2166/Del/2011 28 Cornell Overseas (P) Ltd. that the quality of goods which will be supplied by the assessee company after its production should match to the requirements of the AE so that it does not suffer any risk in selling them in the competitive market and that in an arrangement, where the reward of the marketing was enjoyed by the AE and similarly the fruits of intangibles such as logo are being plucked by the other party, the contract manufacturer cannot have been load with the expenses of those items. According to him, the contract manufacture should be more concerned about markup on the cost of manufacturing of the products being manufactured on behalf of the other party. The TPO referred to the guidelines of OECD in respect of exploitation of intangibles and stated that these guidelines are very useful in determination of price and benefits to the respective parties to the agreement of authorizing the use of intangibles. The said guidelines read as under: "6.14 Arm's length pricing for intangible property must take into account for the purposes of comparability the perspective of both the transferor of the property and the transferee. From the perspective of the transferor, the arm's length principle would examine the pricing at which a comparable independent enterprise would be willing to transfer the property. From the perspective of the transferee, a comparable independent enterprise may or may not be prepared to pay such a price, depending on the value and usefulness of the

ITA No. 2166/Del/2011 29 Cornell Overseas (P) Ltd. intangible property to the transferee in its business. The transferee will generally be prepared to pay this license fee if the benefit it reasonably expects to secure from the use of the intangibles is satisfactory having regard to other options realistically available. Given that the licensee will have to undertake investments or otherwise incur expenditures to use the licence it has to be determined whether an independent enterprise would be prepared to pay a licence fee of the given amount considering the expected benefits from the additional investments and other expenditures likely to be incurred." 33. The TPO further observed that in some circumstances, the price of intangibles may stand included in price of goods either sold by the AE or purchased from the AE by the related party. In such circumstances, AE may built in value of intangible in cost of goods transacted and these arrangements are recognized by OECD in following terms: “6.17 The compensation for the use of intangible property may be included in the price charged for the sale of goods when, for example, one enterprise sells unfinished products to another and, at the same time, makes available its experience for further processing of these products. Whether it could be assumed that the transfer price for the goods includes a licence charge and that, consequently, any additional payment for royalties would ordinarily have to be disallowed by the country of the buyer, would depend very much upon the circumstances of each deal and there would appear to be no general principle which

ITA No. 2166/Del/2011 30 Cornell Overseas (P) Ltd. can be applied except that there should be no double deduction for the provision of technology. The transfer price may be a package price, i.e., for the goods and for the intangible property, in which case, depending on the facts and circumstances, an additional payment for royalties may not need to be paid by the purchaser for being supplied with technical expertise. This type of package pricing may need to be disaggregated to calculate a separate arm's length royalty in countries that impose royalty withholding taxes." 34. The TPO pointed out that the assessee company was making its total sales to the related parties and the benefit of producing quality of garments was reaped by overseas entity, the payment of charges for royalty or technical know-how did not confirm to arm’s length principle. The payment of royalty/technical know-how to the extent of Rs.1,57,35,495/- in an international transaction was treated to be a payments against services having arm’s length value at Nil.

ITA No. 2166/Del/2011 31 Cornell Overseas (P) Ltd. as to why the amount of Rs. 1,57,35,495/- being shown as royalty paid be not disallowed and added back to the income of the assessee u/s 92CA (4) read with 92C(4). It was further required to show cause as to why, without prejudice to the order of TPO, the royalty of Rs. 1,57,35,495/- be not disallowed as being not incurred wholly and exclusively for the purposes of business of the assessee. No reply to these queries raised was given in the letter dated 23.03.2006 filed on 24.03.2006. However, in a response to query regarding justification of payment covered u/s 40A (2) (b) raised earlier the assessee had simply stated that payment was made to PRC, USA who have supplied designs and know-how for manufacture of garments, in view of the discussion in paras 4.1 & 4.2 and without prejudice to the order of the TPO. I hold that the expenditure of Rs. 1,57,35,495/- on account of royalty has not been laid out wholly and exclusively for the purposes of business of the assessee. Having been held that the payment of royalty of Rs. 1,57,35,495/- is treated to be a payment against services having NIL arm's length value, the amount of Rs.1,57,35,495/- is added to the total income of the assessee u/s 92 CA (4) read with 92C (4). It is also noted that tax deducted on royalty of Rs.31,51,353/- was not deposited in time. The assessee has on its on added back this amount u/s 40 (a) in the computation of income. However, the assessee is not entitled to deduction u/s 80HHC on this enhancement of income as per first proviso to section 92C (4).” 36. Being aggrieved the assessee carried the matter to the ld. CIT(A) and submitted as under:

ITA No. 2166/Del/2011 32 Cornell Overseas (P) Ltd. “A. Disallowance under wrong section The disallowance made by the AO has been made on the grounds that the payment of royalty is not wholly and exclusively for business purposes and has been made u/s 92C(4) read with section 92CA(4). A disallowance u/s 92C(4) read with section 92CA(4) is made only when the quantum of a international transaction is not as per the arms' length price. Whether a particular international transaction (i.e. payment of royalty in this case) between associated enterprises has been laid out wholly and exclusively for business purposes, is to be judged under section 37 of the IT Act and not under section 92. Hence the AO has erred in law in disallowing the above amount u/s 92. B. Royalty is wholly and exclusively for business purposes Without prejudice to the above, it is stated that irrespective of the section under which the AO has disallowed the royalty payment, the AO has erred on facts in concluding that the royalty payment is not wholly and exclusively for business purposes. In reaching the above conclusion, the AO has disregarded the findings of his predecessor who has not only concluded that the payment of Royalty has been made wholly and exclusively for business purposes but has also agreed to the quantum of royalty.

ITA No. 2166/Del/2011 33 Cornell Overseas (P) Ltd. For the year ended March 31, 2002, the payment of Royalty was considered a payment laid out wholly and exclusively for the business purposes and the amount paid was considered well within the ALP. These findings were recorded in the order passed by the AO under section 143(3) of the IT Act. Subsequently, the AO issued a notice under section 148 and after hearing the matter, concluded that the Royalty paid was a capital expenditure and not a revenue expenditure. The CIT(A) - VI, New Delhi heard the appeal and held that the Royalty was a revenue expenditure and was expended wholly and exclusively for the purposes for the business of the assessee. A copy of the order is attached for your perusal (attachment -2). Further, the AO has not respected the established judicial principle that the business expediency of a particular payment has to be judged by the assessee and not by the AO. Further the AO has brought nothing on record to show that the payment has not been made for business reasons. Under section 92, the onus of proving the adequacy or establishing the ALP of an international transaction is on the assessee which in the present case has been discharged. Further, the onus of proving that a particular payment is not for business purpose has been discharged by the appellant in the course of the appellate hearing against the order of the AO u/s 147 and the same has been accepted by the CIT(A) for the earlier year. The order of the CIT(A) clearly establishes the fact that the technical assistance received by the appellant has greatly

ITA No. 2166/Del/2011 34 Cornell Overseas (P) Ltd. benefited the appellant and has helped it earn adequate profits. The fact that the appellant has earned profits which are higher than the industry average has been acknowledged by the TPO in para 2.1 of his order. It is pertinent to note that the gross margins computed by the appellant have been computed after considering the payment of royalty. The TPO has acknowledged that the gross margins earned by the appellant are higher than the average industry margins. C, The TPO has determined the ALP by applying a non specified method: Merely because royalty payments were relating to the product sold by the assessee to its associated enterprises cannot be the consideration before the TPO for determining 'ALP' of the Royalty payments as Nil. Specific methods have been prescribed in the Act and the I. T. Rules and the T.P.O. is bound to determine 'ALP' of any international transaction within the framework of the method prescribed by statute. Section 92C which deals with the specific methods is reproduced below for your ready reference: Computation of arm's length price. 92C. (1) The arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or

ITA No. 2166/Del/2011 35 Cornell Overseas (P) Ltd. junctions performed by such persons or such other relevant factors as the Board may prescribe, namely:— (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub- section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: [Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean.] (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that— (a) the price charged or paid in an international transaction has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction have not been kept and

ITA No. 2166/Del/2011 36 Cornell Overseas (P) Ltd. maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm's length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub- section (3) of section 92D, the Assessing Officer may proceed to determine the arm's length price in relation to the said international transaction in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer. (4) Where an arm's length price is determined by the Assessing Officer under sub-section (3), the Assessing Officer may compute the total income of the assessee having regard to the arm's length price so determined: 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

ITA No. 2166/Del/2011 37 Cornell Overseas (P) Ltd. 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 manner in which the A.L.P is to be determined by any of the method prescribed in Sec. 92C in provided in Rule 10B of the I. T. Rules, 1962. After examining the parameters prescribed in Rule 10B, it can be seen that merely because royalty payments were made to one of the associated enterprises on sales made to the associated enterprises cannot be a factor to determine the arm's length price of Royalty. It is humbly submitted that the TPO has exceeded his limitation by following the method which is not authorised under the Act or rules and hence the ALP determined by the TPO and adopted by the AO in respect of the Royalty payable is not as per the procedure prescribed and cannot be sustained. The above conclusion is supported by the decision of the Mumbai bench of the ITAT in the case of CA Computer Associates vs DCIT. A copy of the case is attached for your ready reference. D. The TPO has erred in holding that the appellant is a Contract Manufacturer

ITA No. 2166/Del/2011 38 Cornell Overseas (P) Ltd.

The TPO in his order has held the appellant to be a contract manufacturer. In arriving at this conclusion, the TPO has grossly erred in appreciating the functional profile of the appellant. In this connection it is stated that the appellant is a full fledged, risk bearing manufacturer and is not a limited risk contract manufacturer. In support of this contention, the following points are submitted: 1. For the purposes of establishing the ALP of the export of garments, the appellant has compared itself with full fledged and risk bearing manufacturers, a comparison which has been accepted by the TPO. Hence the TPO has himself acknowledged that for the purposes of manufacture of garments, the appellant is a full fledged manufacturer and is not a contract manufacturer; 2. According to the Her Majesty's Revenue and Customs (HMRC) Transfer Pricing Manual para 465060, a contract manufacturer is the first step away from a licensed manufacturer. It still owns plant & machinery and employs a skilled labour force, but instead of making goods, holding them as stock and selling them to distributors, the goods are made for the principal. This means the contract manufacturer has none of the risks associated with holding finished goods, or of selling those goods. Provided it meets a specified quality, and quantity, the principal will guarantee to buy all the goods manufactured. In the given case, none of the above characteristics of a contract manufacturer are present with the appellant.

ITA No. 2166/Del/2011 39 Cornell Overseas (P) Ltd. The licensed manufacturer will be making goods under a relatively long-term licence agreement. It will use manufacturing intangibles owned by the licensor, such as patents, industrial know-how, designs, etc. In return it will usually pay an annual royalty. It may own some of the manufacturing intangibles used in the production process. It will buy raw materials and semi-assembled goods on its own account and will hold stock of both raw materials and finished goods. It will be subject to the risks of selling the goods. It will need to invest in skilled labour and expensive plant and machinery. All the above characteristics are present in the case of the appellant and hence the appellant is a licensed manufacturer. 3. The appellant is registered with the Central Excise authorities as a full fledged manufacturer and is not treated as a contract manufacturer. A contract manufacturer as is evident from the definition given above, does not hold raw material inventory risk, however in this case the appellant holds the entire raw material on its own account. This is evident from the fact that the appellant is eligible for all the export benefits which are available on the purchase of raw materials like DEPB etc. 4. A contract manufacturer does not take the risk of bad debts. In fact this is one of the most important characteristics of a contract manufacturer. The appellant has taken the bad debt risks for all its sales as is evident from the FAR analysis mentioned in the TP Report. Also in the future years, the appellant has had bad debts and the same have been accounted for in its books of accounts as such and

ITA No. 2166/Del/2011 40 Cornell Overseas (P) Ltd. have not been passed on to the associated enterprises. This again establishes the fact that the appellant is not a contract manufacturer but is a licensed manufacturer. 5. Para 9.27 of REPORT ON THE TRANSFER PRICING ASPECTS OF BUSINESS RESTRUCTURINGS CHAPTER IX OF THE TRANSFER PRICING GUIDELINES issued on 22 July 2010 outlines the relationship between the contract manufacturer and the principal by way of an example. Suppose now that a principal hires a contract manufacturer to manufacture products on its behalf, using technology that belongs to the principal. Assume that the arrangement between the parties is that the principal guarantees to the contract manufacturer that it will purchase 100% of the products that the latter will manufacture according to technical specifications and designs provided by the principal and following a production plan that sets the volumes and timing of product delivery, while the contract manufacturer is allocated a guaranteed remuneration irrespective of whether and if so at what price the principal is able to re-sell the products on the market. Although the day-to-day manufacturing would be carried on by the personnel of the contract manufacturer, the principal would be expected to make a number of relevant decisions in order to control its market and inventory risk, such as: a. the decision to hire (or terminate the contract with) that particular contract manufacturer,

ITA No. 2166/Del/2011 41 Cornell Overseas (P) Ltd. b. the decision of the type of products that should be manufactured, including their technical specifications, and c. the decision of the volumes to be manufactured by the contract manufacturer and of the timing of delivery. The principal would be expected to be able to assess the outcome of the manufacturing activities, including quality control of the manufacturing process and of the manufactured products. The contract manufacturer's own operational risk, e.g. the risk of losing a client or of suffering a penalty in case of negligence or failure to comply with the quality and other requirements set by the principal, is distinct from the market and inventory risks borne by the principal. None of the above relationship parameters are present in the case of the appellant and the associated enterprises from whom the Intellectual Property Rights are taken. The appellant is not granted any guaranteed remuneration which is the hall mark of the relationship between a contract manufacturer and the principal. In this case the appellant has sold the finished goods to the associated enterprises at a price which is higher than what would have been available to the appellant from an independent buyer. This is evident from the fact that the gross margins and net margins earned by the appellant are higher than those of the industry, a fact acknowledged by the TPO himself. 6. The contract manufacturer as a rule does not recover the amount of payments made towards the

ITA No. 2166/Del/2011 42 Cornell Overseas (P) Ltd. IPR from the sale of goods since the goods are being manufactured for the principal However, in this case the entire amount paid as royalty has been recovered from the price of the goods sold to the associated enterprises. This is evident from the fact that the gross margins computed by the appellant have been computed after considering the royalty as an expense and these gross margins are greater that the average industry margins. E. Royalty Computed on Sates, Including Sates to Associated Enterprise Itself, Satisfies Arm's Length Standard When Taxpayer Is Not a Contract Manufacturer Since the appellant is not a contract manufacturer, whatever royalty is paid (even if it is paid on the sales to associated enterprises) if recovered from the sales made has to be considered as being paid at ALP. The Delhi bench of the Income-tax Appellate Tribunal held that the taxpayer's payment to an associated enterprise of a royalty—the amount of which was computed based on sales made to the associated enterprise itself—complies with the arm's length standard when the taxpayer is not a contract manufacturer and the royalty payment is recovered from the associated enterprise as part of the selling price. ACIT v. Sona Okegawa Precision Forging Ltd. [2010-TII-41-ITAT-DEL-TP] The case is briefly explained in the paragraphs below:

ITA No. 2166/Del/2011 43 Cornell Overseas (P) Ltd. Background During Financial Year 2003-04, the taxpayer paid a royalty to its associated enterprise, and the royalty payment was benchmarked under the Comparable Uncontrolled Price (CUP) method—by relying on the ceiling under the Foreign Exchange Management Regulations— as the arm's length price. During the course of transfer pricing assessment proceedings, the Transfer Pricing Officer proposed a transfer pricing adjustment in relation to the royalty transaction, based on the following: • The taxpayer had not entered into an agreement for the payment of a royalty to any independent third party; hence, there was no comparable uncontrolled data. • The royalty was paid on total sales of the taxpayer, including sales made to the associated enterprise, and a royalty paid to an associated enterprise computed on the basis of sales made to the associated enterprise itself was not compliant with the arm's length standard. The taxpayer filed an appeal with the Commissioner of Income Tax (Appeals) [CIT(A)], who rejected the adjustment proposed by the transfer pricing officer. Tribunal's Decision The tribunal upheld the order of the CIT(A) in favor of the taxpayer, and reached the following conclusions:

ITA No. 2166/Del/2011 44 Cornell Overseas (P) Ltd. • The royalty paid by the taxpayer, computed on the basis of sales made to the associated enterprise, was at arm's length given that the taxpayer was not a contract manufacturer. Further, the amount paid as a royalty was recovered by the taxpayer from the associated enterprise as part of the sale price; thus, the transaction was revenue neutral. F. Inter-Company Agreements for Royalty and Know-How Fees, Approved by Regulatory Agencies* Cannot Be Disregarded, in the Absence of a Showing that the Agreements Were Not Genuine The payments made by the appellant on account of royalty are well within the limits permitted by the Reserve Bank of India. Further, the appellant has made full compliance of the Service Tax regulations by making the appropriate Service Tax payments on these Royalty payments. Since the payments have been made under legally valid and genuine agreements the payments must be considered as being at ALP. The Delhi Tribunal held that legally binding inter- company agreements for the payment of royalty and technical know-how fees, that have been duly approved by regulatory agencies, cannot be disregarded by the Transfer Pricing Officer merely because of a finding that there was no commercial need for the arrangement. Abhishek Auto Industries Limited v. Deputy Commissioner of Income Tax [201O-TII-54-ITAT-DEL-TP] (12 November 2010, Assessment Year 2004-05).

ITA No. 2166/Del/2011 45 Cornell Overseas (P) Ltd. The tribunal noted that commercial expediency is the domain of the taxpayer and that it had not been alleged by the tax authorities that the agreement was non-genuine or that it was a sham. The case is briefly explained in the paragraphs below: Background The taxpayer is an Indian company engaged in manufacturing of car seat belts for the Indian domestic market. For specific categories of seat belts, the taxpayer imports raw materials and avails technical know-how from its associated enterprise for assembling the seat belts, which are then supplied to India's domestic car manufacturers. In the transfer pricing documentation for financial year (FY) 2003-04, the taxpayer had stated that the raw material imported from the associated enterprise was not available from any other supplier and, hence, it was difficult to ascertain an arm's length price for this transaction. In relation to the transaction for payment of the royalty and technical know-how, it was asserted that because the payments were made in accordance with agreements approved by regulatory agencies, the question of arm's length compliance did not arise. Additionally, before the Transfer Pricing Officer, the taxpayer compared the gross profitability of its associated enterprise and of non-associated enterprise operations for demonstrating compliance with the arm's length standard.

ITA No. 2166/Del/2011 46 Cornell Overseas (P) Ltd. The Transfer Pricing Officer rejected the arm's length analysis of the taxpayer, based on the following observations: • The arm's length price of the international transactions for the payment of royalty and technical know-how fees was "nil" because no transfer of technology had taken place, and these payments are already bundled in price of the raw material imported from the associated enterprise. The taxpayer appealed to the Commissioner of Income Tax (Appeals), who while endorsing the view of the Transfer Pricing Officer, further enhanced the adjustment based on updated profit margins of the comparables selected by the Transfer Pricing Officer. Tribunal's Decision The tribunal ruled in favor of the taxpayer. The key aspects of tribunal's order are summarized, as follows: • The tax authorities erroneously disregarded the royalty and know-how agreement (which was approved by regulatory agencies) merely by pleading the absence of any commercial need for such agreement. The tribunal observed that commercial expediency is the domain of the taxpayer and because it had not been alleged by the tax authorities that the agreements were non-genuine or shams, they could not be rejected arbitrarily without assigning cogent reasons.

ITA No. 2166/Del/2011 47 Cornell Overseas (P) Ltd. CONCLUSION From the above it is evident that the TPO and the AO have erred in considering the ALP of the royalty as NIL and accordingly you are requested to delete the addition of Rs. 1,57,35,495/-”. 37. The ld. CIT(A) after considering the submissions of the assessee observed that the royalty payment was included in the sale price of the garments so it was automatically benchmarked at arm’s length. She further observed that the international transaction of export of garments was benchmarked at arm’s length using Cost Plus Method and the royalty expenses had been reduced to arrive at gross profit for the purposes of benchmarking international transaction of export of garments, the gross profit margin earned by the assessee was 19% whereas comparables had earned gross margin between 12% - 16% which was acknowledged by the TPO vide para 2.1 of his order dated 09.03.2006. The ld. CIT(A) further observed that since the international transaction of royalty of export of garments had been clubbed to arrive at the gross profits and if the gross profit margins are at arm’s length, automatically it followed that both the international transactions are at arm’s length. The reliance was placed on the decision of the ITAT Delhi Bench in the case of ACIT Vs Sona Okegawa Precision

ITA No. 2166/Del/2011 48 Cornell Overseas (P) Ltd. Forging Ltd. (2010)-TII-41-ITAT-Del-TP wherein it has been held as under: "royalty paid by the taxpayer , computed on the basis of sales made to the associated enterprise, was at arm's length given that the taxpayer was not a contract manufacturer. Further, the amount paid as a royalty was recovered by the taxpayer from the associated enterprise as a part of the sale price; thus, the transaction was revenue neutral." In view of the above, the addition made by the AO was deleted.

ITA No. 2166/Del/2011 49 Cornell Overseas (P) Ltd. decision of the ITAT Delhi Bench relied by the ld. CIT(A) is not applicable to the facts of the present case because in the said case bulk of goods were sold to independent parties but in the case of the assessee, 100% of the goods were sold to the AEs. Moreover, the assessee was a contract manufacturer and was manufacturing the garments on the strict instructions and specifications given by the AEs and the AE was charging royalty on the sale made to itself. It was further submitted that since the assessee was selling only to its AEs hence it was not in a position to commercially exploit the trademark or technical know-how and thus it derived no benefit. It was further stated that there was no need as the assessee was a 100% captive service provider and “contract manufacturer” and was manufacturing garments on the specifications, designs and instructions of the AEs for that purpose the assessee had been permitted to use the trademark know-how etc. only for sales made to the AEs, thus, CUP had been correctly computed at Nil and no independent party would have paid for the royalty under similar circumstances. The reliance was placed on the decision of the ITAT Delhi Bench in the case of GE Money Financial Services (P.) Ltd. reported at (2016) 69 Taxman 420 and Judgment of the Hon’ble Delhi High Court in the case of Cushman and Wakefield (2014) 46 Taxman 317 (Del.).

ITA No. 2166/Del/2011 50 Cornell Overseas (P) Ltd. 39. In her rival submissions the ld. Counsel for the assessee supported the impugned order passed by the ld. CIT(A) and reiterated the submissions made before the authorities below. It was further submitted that the transaction of payment of royalty was revenue neutral because assessee charged royalty by embedding it in sale price from AEs to whom goods were sold and paid to other AE i.e. PRC, USA. A reference was made to page no. 206 of the assessee’s paper book. It was further stated that the ld. CIT(A) observed that the royalty was included in the sale price and was part of cost charged from AEs and that the royalty expenses had been reduced to arrive at Gross Profit for the purpose of benchmarking international transaction of export of garments, the gross profit mark-up earned by the assessee was at 19% after reducing royalty whereas industry had earned mark-up of 12-16%, therefore, royalty transaction was also at arm’s length. It was pointed out that the assessee was recovering royalty from AEs by including it in the price quoted to the buyer and the royalty was also part of cost of production, therefore, arm’s length nature of royalty expenses was established while benchmarking international transaction of export of sales. It was stated that the royalty agreement was effective from 02.04.2001 and the TPO had accepted in assessment year 2002-03 that the assessee was a full fledged

ITA No. 2166/Del/2011 51 Cornell Overseas (P) Ltd. risk bearing manufacturer and entitled to pay royalty to AEs. A reference was made to page nos. 146 & 147 of the assessee’s paper book. It was further stated that the functional, and risk profile of the assessee remain the same in the assessment year under consideration as was in the preceding year, therefore, treating the assessee as contract manufacturer in the year under consideration, despite same underlying facts amounts to taking inconsistent stand by the TPO year on year. The reliance was placed on the following case laws: � Radhasoami Satsang Vs CIT (1992) 193 ITR 321 (SC) � Hoystead Vs CIT (1926) AC 155 (PC) � Parashuram Pottery Works Co. Ltd. Vs ITO (1977) 106 ITR 1 (SC) � CIT Vs Excel Industries Ltd. (2013) 358 ITR 295 (SC) � Dalmia Promoters Developers (P) Ltd. (2006) 151 Taxman 202 (Del.) 40. It was contended that the agreement with PRC, USA was for licensing of technical know-how, trade names and trade- marks by PRC, USA to assessee and not a contract manufacturing agreement. Therefore, the TPO sought to re- write the agreement which is not permissible in law as the legally binding agreements cannot be disregarded without assigning any cogent reasons thereto. The reliance was placed on the following case laws:

ITA No. 2166/Del/2011 52 Cornell Overseas (P) Ltd. � Honda Siel Power Products Ltd. Vs DCIT (2016) 283 CTR 322 (Del.) � Abhishek Auto Industries Ltd. Vs DCIT in ITA No. 1433/Del/2009 41. The ld. Counsel for the assessee submitted that the TPO failed to understand that international transactions of assessee were with separate legal entities and the owner of technical know-how, designs, trade names, logos and trademarks, namely, PRC, UAS was to be compensated for services rendered. It was also submitted that the assessee could not have been the contract manufacture of its buyer AEs as none of them own intangibles or possess technical know-now as they were mere retailers or distributors and that the assessee could not be a contract manufacturer of PRC, USA as the assessee neither purchased anything from it nor sold anything to it. It was submitted that for the purpose of establishing the ALP of export garments (Rs.35.10 Crores), the assessee had compared itself with companies which were full fledged risk bearing manufacturers and the comparison had been accepted by the TPO. Therefore, the TPO had himself acknowledged that for the purposes of manufacture and export of garments, the assessee was full fledged manufacturer and not contract manufacturer. A reference was made to page no. 221 of the assessee’s paper book. The reliance was placed on the decision

ITA No. 2166/Del/2011 53 Cornell Overseas (P) Ltd. of ITAT Delhi Bench in the case of Kehin Panalfa ltd. in ITA No. 3287/Del/2011 & 5546/Del/2012. It was further submitted that the assessee had undertaken all business risks, inventory risk related to obsolescence, risks related to procurement of raw material and asscessories, spent on research & development and hence had taken R&D risk, marketing risk, production & planning risks and the quality risk. It was further stated that as per the TPO’s own admission, the contract manufacturer did not take market risk whereas the assessee was undertaking market risk as it traded in open market conditions and bears risks of excessive supply, presence of competitors, risk of advent of new designs in the market etc. It was contended that the design and technical know-how was being provided under the technical know-how and trade name licensing agreement. Therefore, the TPO was factually incorrect in inferring that since the assessee was contract manufacturer, therefore, it was being provided with this guidance and was required to adhere to basic quality parameters under the licensing agreement so that trade name of licensor was not damaged which was present in every technical assistance and trade name licensing agreement done in the open market conditions. It was stated that the TPO was factually incorrect in stating that all the sales were to the AEs, particularly when, the assessee had exported to non AEs as

ITA No. 2166/Del/2011 54 Cornell Overseas (P) Ltd. well. It was also stated that the assessee purchased raw material and semi-finished goods from third parties on its own behalf and not on behalf of AEs, with whom the assessee transacted on principal to Principal basis in open market conditions, so it was free to manufacture and sell to outside world as there was no restriction and the assessee in fact had sold to third parties during the year, which had increased substantially in subsequent years. It was submitted that the assessee was not guaranteed any remuneration which was the hall mark of the relationship between contract manufacturer and the principal and that the buyer AEs had no say or control of any nature on decision of volume of production, terms of sale and inventory etc. It was stated that the contract manufacturer did not take bad debit risk whereas assessee had taken bad debt risk and in future years, the said bad debts had been accounted for in its books of account. It was further stated that the assessee purchased and held raw material and furnished goods on its own account, valued inventory at cost or market price whichever was less, therefore, corresponding risk of inventory being out of market was taken by the assessee. A reference was made to page no. 73 of the assessee’s paper book which is the copy of financial statements. It was pointed out that in the assessment year 2006-07, there had been loss of Rs.2.4 crores

ITA No. 2166/Del/2011 55 Cornell Overseas (P) Ltd. on account of revaluation of inventory which were borne by the assessee. It was contended that the contract manufacturer as a rule does not recover the amount of payments made towards the IPR from the sale of goods since the goods are being manufactured for the principal. However, in this case the entire amount paid as royalty had been recovered from the price of the goods sold to the AEs, which was evident from the fact that gross margins were computed after considering the royalty as expense. It was further contended that the OECD guidelines quoted by the TPO were applicable where tested party was purchasing unfinished goods from AE as well as availing services for further processing of those unfinished goods from the AE. Thus, the guidelines seek to provide a guard lest there is duplication of payment by tested party for technology; first by way of increased price of goods purchased and again by way of royalty. However, the assessee is procuring raw material from independent parties from open market and was availing technical assistance from one AE and the finished products were sold to some other AEs. Therefore, the OECD guidelines cited by the TPO were not applicable to the facts of the assessee’s case. It was submitted that the contract manufacturer is a step away from licensed manufacturer because it owns plant and machinery and employs skilled labour force but

ITA No. 2166/Del/2011 56 Cornell Overseas (P) Ltd. instead of making goods, holding them as stock and selling them to distributors, the goods are made for principal and that the contract manufacturer has none of the risks associated with holding finished goods, or selling those goods and the principal will guarantee to buy all the goods manufactured, provided it meets a specified quality and quantity, but in the assessee’s case none of the characteristics of contract manufacturer were present. It was further submitted that the TPO acknowledged in the assessment year 2002-03 that the benefit was derived under the “technical assistance, trademark and royalty agreement” which was effect from 02.04.2001 and even the AO accepted that the assessee had derived benefit under the royalty agreement and only dispute was raised whether it was capital expenditure or revenue expenditure. It was stated that the benefit derived under the agreement was proved before the TPO by explaining the Royalty Agreement, the necessity of obtaining designs and business practice in which the assessee operated. It was further stated that technical know-how assistance and designs received under the agreement was backbone of assessee’s production & sale and under the licensing agreement, the assessee had also got right to use on its finished products, trade names and trade-marks owned by PRC and that having got the technical expertise/guidelines from

ITA No. 2166/Del/2011 57 Cornell Overseas (P) Ltd. PRC, USA and its trade mark and trade-names, the assessee was able to access the said markets, mainly in the USA. It was also stated that the manufacturing and export by the assessee was based on know-how, designs and trade-mark provided by PRC, USA, so the assessee was the real beneficiary and the TPO had not doubted that manufacturing was with the technical assistance provided by PRC and final product bears the registered trade mark and trade name of Aplil Cornell. It was stated that even the TPO had not questioned the method of benchmarking and rate of royalty, in fact, in assessment year 2002-03 under the same agreement, rate of royalty at 5% was found to be at arm’s length by the TPO. A reference was made to page nos. 146 & 147 of the assessee’s paper book which is the copy of the TPO’s order for the assessment year 2002-03. It was submitted that on the basis of principal of consistency, the TPO was not justified in considering the ALP at Nil, even when the Instruction No. 3 of 2003 dated 20.05.2003 issued by the CBDT clearly stated that in order to maintain uniformity of procedure and to ensure that work in this important area proceeds smoothly and effectively, the guidelines are issued. The reliance was also placed on the following case laws: � CIT Vs EKL Appliances Ltd. in ITA Nos. 1068 & 1070/2011 (Del.)

ITA No. 2166/Del/2011 58 Cornell Overseas (P) Ltd. � LG Electronics India Pvt. Ltd. Vs ACIT in ITA No. 5140/Del/2011 (ITAT S.B.) � Kodak India Pvt. Ltd. Vs ACIT in ITA No. 7349/Mum/2012 (ITAT Mumbai) � Sony Ericsson Mobile Communications India Pvt. Ltd. (2015) 374 ITR 118 (Del.) � Cushman & Wakefield (India) Pvt. Ltd. (2014) 367 ITR 730 (Del.) � Hero Honda Motors in ITA No. 5130/Del/2010 (ITAT Delhi) � Dresser Rand India Pvt. Ltd. in ITA No. 8735/Mum/2010 (ITAT Mumbai) � CA Computer Associates Vs Assessee in ITA Nos. 5420 & 5421/Mum./2006 (ITAT Mumbai) � LGE & C-NCC (Joint Venture) Vs ITO in ITA Nos. 281/Hyd./2011 and 1021/Hyd./2012 (ITAT Hyderabad) � SC Enviro Agro India Ltd. Vs DCIT in ITA Nos. 2057 & 2058/Mum./2009 (ITAT Mumbai) 42. We have considered the submissions of both the parties and carefully gone through the material available on the record. In the present case, it is not in dispute that the assessee entered into an agreement with its AE i.e. Pike River Corporation (PRC), USA under “Technical Assistance, Trade-Mark and Royalty Garments” for use of technical know-how, designs, logos, trade names, and trade-marks. The royalty was paid @ 5% on net sale of products manufactured with the technical assistance of PRC, USA. The royalty agreement was effective from 02.04.2001 and for the assessment year 2002-03, the

ITA No. 2166/Del/2011 59 Cornell Overseas (P) Ltd. royalty payment was accepted by the TPO at arm’s length. However, the AO considered that the royalty was a capital expenditure and not the revenue expenditure. Being aggrieved the assessee carried the matter to the ITAT in ITA No.4739/Del/2010 wherein vide order dated 30.03.2016 it has been held as under: “8. Ground No.2: The assessee has debited sum of Rs.1,26,58,195/- on account of royalty payment, which has been disallowed by the Assessing Officer on the ground that the said amount is capital in nature as the assessee in its reply has himself used the words “product from the design and know-how”. Ld. A.R. contended that the royalty payment has been made only for the purpose of running the business being an integral part of the profits earning process and not for acquiring an asset / enduring advantage. 8.1 To decide the controversy at hand, relevant provisions of agreement dated 02.04.2010 made between the assessee company with Pike River Corporation holding all the rights to licencee in name of ‘April Cornell Label’ and several other trade names. Undisputedly, the assessee company is engaged in manufacturing and sales of clothing, apparels, house hold products and related merchandise and entertainment agreement with Pike River Corporation to the following effect:- “2. 1 The LICENSOR hereby grants to the LICENSEE a non-transferable, right and license within the TERRITORY:

ITA No. 2166/Del/2011 60 Cornell Overseas (P) Ltd. a. To manufacture and/or cause to be manufactured and to distribute and/or sell products reproduced from designs created by LICENSOR or prepared by LICENSEE and approved by LICENSOR under the terms and conditions hereinafter set forth (the "Products"); The LICENCEE shall not at any time, have the right to manufacture the Products reproduced from the designs created by the LICENSOR outside the territory either directly or indirectly, without the prior, written consent of the LICENSOR. b. To use LICENSOR’s know-how and designs, in connection with the manufacture and sale of the Products; 2.2 The License herein granted shall only extend to the top quality products, designed, manufactured, promoted, advertised and sold according to the highest standards of the industry and in full compliance with the terms and conditions Hereof, so as to maintain, enhance and protect the image and prestige associated with the Name. 3.1 LICENSEE shall only use the Name, the Label and the Marks as authorized and, provided herein and in full compliance with the terms and conditions hereof and only for the duration of this Agreement. The license herein granted shall confer unto LICENSEE no proprietary rights whatsoever in the name or "APRIL CORNELL", the Marks or the goodwill now attached or hereafter to become attached thereto.

ITA No. 2166/Del/2011 61 Cornell Overseas (P) Ltd. 4.6 (LICENSEE, its agents and its employees shall keep any and all elements of LICENSOR's know-how strictly confidential and w111 refrain from using such ( know-how for any purpose other than the purpose of this Agreement. Upon termination thereof for any reason whatsoever, LICENSEE will return to LICENSOR any and all elements of LICENSOR’s know-how fixed in a tangible medium of expression.” 8.2 A perusal of the provisions of Agreement (supra) goes to prove that the assessee company has made the royalty payment to manufacture/sell products designed by licensor and also used its name, the label and the mark and has also availed technical assistance having limited right during subsistence of agreement for the aforesaid technical knowhow / use of name label and mark and technical assistance of the licensor. Assessee paid 5% of the net sales of the product during each year of the agreement. Now, the question arises for determination is, “as to whether payment of Rs.1,26,58,195/- on account of royalty payment is to be capitalized or is revenue expenditure?” 8.3 A perusal of the terms and conditions of agreement (supra) goes to prove inter alia; that the same was made for a specific period of seven years i.e. w.e.f. 01.04.2001 to 31.03.2008; that the assessee was made to pay 5% of the net sales of the product during such term and year of agreement for the use of knowhow, label and mark and to avail of consequent technical assistance; that only non- transferable and limited rights to use the aforesaid know how etc have been granted to the assessee; that as per terms of agreement, assessee was made to

ITA No. 2166/Del/2011 62 Cornell Overseas (P) Ltd. return to the licensor any and all the elements of licensor’s know how fixed in tangible medium of expression; that this payment of royalty was to be made on the basis of net sales, meaning thereby, while sales is directly linked with day to day running of business and as such expenditure on account of royalty payment cannot be considered as capital expenditure. 8.4 Ld. A.R. in order to support the impugned order, relied upon the judgement cited as CIT Vs Goodyear India Ltd. (2010) 110 Taxman 59 (Del.). Hon'ble Jurisdictional High Court in the judgement in case of Goodyear India Ltd. (supra) held as under: “Section 37(1) of the Income-tax Act, 1961 - Business expenditure - Allowability of - Assessment year 1984-85 - Assessee-company manufacturing and selling automotive tyres and tubes paid certain amount to foreign company as consideration for agreeing to provide technical know-how for manufacture of extra large OTR tyres - Whether findings recorded by Tribunal that agreement was not made for manufacturing of an entirely new product, that consideration was paid for betterment of product and that assessee had only enlarged range of its existing products were pure findings of fact, and those facts having attained finality, expenditure incurred by assessee was revenue in nature - Held, yes 8.5 Ld. A.R. also relied upon the judgements cited as CIT Vs IAEC (Pumps) Ltd. 232 ITR 316 (S.C.), CIT Vs IAEC (Pumps) Ltd. 110 ITR 353 (Mad.), CIT Vs Steel Plant (P) Ltd. 17 Taxman 301 (Bom.) and CIT Vs Southern Pressings (P) Ltd. 125 Taxman 714 (Mad.). By applying the ratio of judgements cited above relied upon by the Ld. A.R., to the facts and circumstances of the present case, we are of the considered view that

ITA No. 2166/Del/2011 63 Cornell Overseas (P) Ltd. when the expenditure on account of payment of royalty have been paid by the assessee for having access to the technical knowhow, that too for a limited period, the payment was made as a licensee @ 5% of net sales of the product for making use of the knowhow, label and mark and technical assistance and it has not a right to retain the knowhow, mark or label as absolute owner, such an expenditure cannot be capitalized and the same are revenue expenditure. Consequently, ground No.2 is determined against the revenue.” 43. In the present case, it is not brought on record that the aforesaid decision of the ITAT has been reversed by the higher form, therefore, by keeping in view the principle of consistency, we are of the confirmed view that the ld. CIT(A) was fully justified in deleting the addition of Rs.1,57,35,495/- made by the AO, particularly, when the benefit derived under the agreement dated 02.04.2001 was not doubted by the TPO and the assessee by using the technical know-how assistance and designs received under the said agreement was manufacturing the finished products which were sold to the AE as well as to the other parties. Therefore, the assessee derived benefit under the royalty agreement and it was accepted by the AO for the assessment year 2002-03. However, the only dispute raised by the AO in the said assessment year was as to whether the royalty payment was a capital expenditure or revenue expenditure. The said dispute has been settled by the ITAT vide

ITA No. 2166/Del/2011 64 Cornell Overseas (P) Ltd. aforesaid referred to order dated 30.03.2016 and it was held that the royalty payment was revenue expenditure and not the capital expenditure. In the present case, the royalty expenditure by the assessee was fully and exclusively incurred in the regular course of business and after incurring this expenditure the assessee declared profit @19% which was better than the GP rate of 12 & 16% declared by the comparables. Therefore, it was at arm’s length and the addition made by the AO was not justified which has rightly been deleted by the ld. CIT(A). We, therefore, considering the totality of the facts, do not see any valid ground to interfere with the findings given by the ld. CIT(A).

Sd/- Sd/- (Beena Pillai) (N. K. Saini) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated: 02/05/2017 *Subodh* Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT(Appeals) 5.DR: ITAT ASSISTANT REGISTRAR