A.W. FABER CASTELL (INDIA) P.LTD,MUMBAI vs. DCIT 9(1)(1), MUMBAI

Grounds 2 to 6 deal with the solitary issued with regard to transfer pricing adjustment made by the AO on account of payment of royalty made by the assessee to its Associated Enterprise (AE) of Rs.1,91,03,040/-. The brief facts in this case are that during the year under consideration the assessee was engaged in the manufacturing and trading of wide range of stationary products. The assessee sold its products in India as well as abroad to its AEs. It was informed that one of its AEs namely M/s A.W. Faber Castell A.G., Germany (in short referred to as ‘AE’) was owner of trademarks and the corporate brand name which assessee used in its product. Since the assessee used the trademark in relation to the sale of the products, therefore in consideration of grant of license and right to use the trademark the assessee paid to its aforesaid AE royalty @ 3% on net sales excluding sales to AEs and sale of non- brand Faber’s products. It was also informed that similar payment was made in AYs 2010-11 and 2011-12 also. In its Transfer Pricing Study Report, the assessee bench marked its transaction of payment of royalty using CUP (Comparable Uncontrolled Price) method. The assessee took help of approval in this regard granted to it vide letter dt 9th March 2005 issued by FIPB Unit of Department of Economic Affairs of Ministry of Finance (Government of India) read with Press Note No 2 dt 24th June 2003 issued by SIA (FC Division) of Department of Industrial Policy and Promotions, Ministry of Commerce & Industry, Government of India and contended before the AO that though the assessee had got approval of making payment up to 8% on exports and 5% of domestic sales, but the payment was made by the assessee to its AE merely at 4 A.W Faber Castell the rate of 3%. Therefore, the same was at Arm’s Length Price as the payment was far below then the rate of approval granted by the government under FEMA rules and industrial norms. However, the AO did not agree with the above contention of the assessee. It was observed by him in the assessment order that no comparable royalty agreement was produced by assessee to justify the CUP method adopted by it. Therefore, AO determined the ‘ALP’ (Arm’s Length Price) at nil in respect of payment of royalty and accordingly made addition of the entire amount of royalty paid by assessee to its AE. It was further brought to our notice that in doing so the AO followed the assessment orders of earlier years i.e. AYs 2010-11 & 2011-12 passed in assessee’s own case. The DRP also followed its earlier orders while endorsing the views of the AO and gave no relief to the assessee.

Our attention was also drawn on page no. 266 of the paper book, which is copy of approval of FIPB Unit of Department of Economic Affairs dated 9th March, 2005 as well as Press Note No.2(2002 series) wherein government had allowed payment of royalty under automatic route up to 8% on exports and 5% on domestic sale. He thus submitted the issue is covered in favour of the assessee.

Per contra, Ld. CIT(DR) vehemently opposed the arguments of Ld. Counsel of the assessee. Firstly, she brought to our notice an order passed by the Tribunal in assessee’s own case for AY 2010-11 wherein the claim of the assessee was not accepted and the issue was sent back to the file of the AO to decide the ‘ALP’ on the basis of the fresh TP study. It was further contended by her that aforesaid letter dated 9th March, 7. 2005 (attached in the Paper Book as Page No. 266) did not grant approval of any specific rate of royalty payable by assessee. It merely referred to the maximum limit which is prescribed by the Ministry of Commerce & Industry in its Press Note No 2 dt 24th June, 2003. Thus, making reference of the higher limit of payment of royalty under the automatic route would not ipso-facto mean that amount of royalty paid by the assessee at the rate of 3% would be its Arm’s Length Price also. As per her view, it would be at the most one of the supporting tools to justify the rate of payment, but it cannot be only and the conclusive proof for justification of ALP. 8. Further, it was also contended by her that the payment made by the assessee on account of royalty was merely for the user of trademark and brand and therefore assessee cannot claim the benefit of rate of 8%, which was meant for those cases of payments where transfer of technology was involved. It was submitted the rates of only 1% and 2% were prescribed in the cases of payment for trade mark user only (i.e. without technology transfer). She also drew our attention on Page No.217 of paper book which is relevant page of the transfer pricing study report submitted by assessee showing FAR analysis of payment of royalty by assessee at the rate of 3% to its AE. She submitted that perusal of the same clearly depicts that no technology was 6 A.W Faber Castell transferred by AE to the assessee and the payment at the rate of 3% was made only for grant of license and right to use the trade mark owned by its AE.

Further, she also brought on record Press Note No.8 (2009 series) dated 16.12.2009 issued by Ministry of Commerce & Industry, Department of Industrial Policy and Promotion (FC Section) which amended the earlier notification issued on the subject of requirement of approval for payment of royalty to the foreign collaborator under different circumstances. The said notification waived all the restrictions levied in this regard and payment of royalty for transfer of technology or for use of trademark/brand was put under the automatically route completely. Thus, no approval of the government of India was required for making such payment. However, such payments remained subject to the Foreign Exchange Management Rules and requirement of post reporting system for payment of royalty was also retained. She also placed before us, copy of the notification dated 15th May, 2010 issued by Ministry of Finance (Department of Economic Affairs) whereby Foreign Exchange Management (Current Account Transaction) Rules, 2010 were suitably amended to bring them in line with the notification issued by Ministry of Commerce & Industry vide aforesaid Press Note No. 8 (2009) dated 16.12.2009. It was submitted that these documents show that there was no restriction on payment of royalty and the same was henceforth under automatic route. Therefore, under these circumstances, it cannot be presumed that whatever payment is made by assessee on account of royalty that would ipso-facto become Arm’s Length Price at its own that too without bringing any other comparable on record or without carrying out any transfer pricing study. If, this kind of approach is allowed then it will make the transfer

In his reply on the next date of hearing, Ld. Counsel of the assessee very fairly submitted that in view of Press Note No-8 (2009 series) dated 16.12.2009 read with notification issued by Ministry of Finance dated 5th May, 2010 for bringing out corresponding amendments in Foreign Exchange Management (Current Account Transaction) Rules, 2010 bring out a change in the legal position i.e. as on date of payment of royalty by the assessee, it was 9 A.W Faber Castell totally under automatic route and no restrictions were left. Under these circumstances, it would be difficult to hold the same as ‘ALP’ on ipso-facto basis. Thus, under these changed factual and legal circumstances an appropriate view may be taken by the Bench. However, it was also submitted that AO was highly unjustified in determining the ‘ALP’ at nil which is highly unfair by any standards. It was submitted that rates approved under FEMA and industrial norms by the concerned authorities carry ample persuasive value and thus it cannot be ignored altogether while determining ALP of the same. Therefore, the matter may be sent back to the AO for fresh examination of all the facts and figures and the Assessing Officer should be directed to permit the assessee to furnish all the evidences in support of its claim to justify the payment of royalty at the rate of 3%.

We have carefully considered the submissions made by both the sides and also gone through various judgments cited before us. The main issue to be decided in these grounds is whether the rate of payment of royalty approved by the Reserve Bank of India under automatic route or the approval granted by the FIPB Unit of Ministry of Finance relying upon the rates prescribed under the automatic route, would itself ‘ipso-facto’ constitute Arm’s Length Price ‘ALP’ under the transfer pricing regulations as provided in Section 92 to 94A of Chapter X of the Income Tax Act, 1961. The assessee contended before the AO that the royalty paid to its AE for user of its trade mark and brand name at the rate of 3% was within the rates allowed by the FIPB unit of Ministry of Finance and, therefore, it was ‘ALP’ price and no further study or substantiation was needed, whereas the AO as well as the DRP were of the opinion that the payment of royalty has to be justified on the basis of ‘ALP’ price to be 10 A.W Faber Castell determined on the basis of independent study to be carried out as per transfer pricing regulations and since no such proper study has been made by assessee, no ‘ALP’ could be determined and thus same was taken at nil. Under these circumstances, total amount of royalty of Rs.1,91,03,040/- paid by assessee to its AE located in Germany was held to be not allowable since it ‘ALP’ was taken it nil and accordingly and upward adjustment of the same amount was made on account of royalty payment.

During the course of hearing before us, Ld. CIT-DR heavily relied upon the decision of the Tribunal in assessee’s own case for assessment year 2010- 11, wherein this issue was held against the assessee and the matter was sent back to the AO for carrying out fresh transfer pricing analysis to determine ‘ALP’ of the royalty payment. She also relied upon a Press Note No. 8 (2009 series) dated 16.12.2009 issued by Ministry of Commerce and Industry whereby restrictions on payment of royalty were waived and the same was put under automatic route. She also relied upon judgment of Hon'ble Delhi High Court and other courts in support of her claim that ‘ALP’ of payment of royalty has to be independently determined. She also distinguished the judgment of Hon’ble Bombay High Court in the case of SGS India Pvt. Ltd. (supra) on the ground that the aforesaid judgment was given on the basis of factual concession only and no ratio or point of law was propounded by the Hon’ble High Court. Thus, she requested for following the order of the Tribunal passed in assessee’s own case for assessment year 2010-11 and for sending the issue back to the file of the AO. On the other hand, Ld. Counsel of the assessee initially relied upon the decision of the Tribunal passed in assessee’s own case for assessment year 2011-12, but subsequently in view of 11 A.W Faber Castell Press Note No.8 (2009 series) having been brought on record by Ld. CIT-DR, he fairly submitted that since all the restrictions have been waived by FIPB/RBI, now the ‘ALP’ needs to be determined independently on the basis of fresh transfer pricing study.

We have carefully considered the intricacies of the issue involved before us. It has been significantly noted by us that Press Note No-8 (2009 series), dated 16.12.2009 reads as under:- “Government of India Ministry of Commerce & Industry Department of Industrial Policy & Promotion (FC Section)

The Government of India has reviewed the extant policy and it has been decided to permit, with immediate effect, payments for royalty, lumpsum fee for transfer of technology and payments for use of trademark/brand name on the automatic route i.e. without any approval of the Government of India. All such payments will be subject to Foreign Exchange Management (Current Account Transaction) Rules, 2000 as mentioned from time to time.

These guidelines issue in modification of provisions relating to foreign technology proposals/approvals contained in paragraphs 3 of Press Note 10 (1991), para 7 of Press Note 11 (1991), para 4 & 5 (a) of Press Note 12 (1991), para 2-6 of Press Note 20 (1991), para 2 of Press Note 5 (1992), para 4 Press Note 4 (1994), para 3 of Press Note 18 (1997) and paragraphs III and IV of Press Note 9 (2000). These guidelines will issue in supersession of provisions of Press Note 18 (1991), Press Note 4 (1992), Press Note 1 (1995), Press Note 4 (1996), Press Note 1 (2002) and Press Note 2 (2003).

A perusal of the aforesaid notification shows that the Government of India has now waived all the restrictions on payment of royalty under foreign technology collaboration and put the same under automatic route. Under these circumstances it is quite obvious now that assessee cannot be permitted to take this stand that since there are no restrictions on payment of royalty by the Government of India, therefore any amount paid by assessee on account of royalty would ipso-facto be its ‘ALP’ also. If this kind of position is allowed to exist then it would amount to simply rendering the transfer pricing regulations as redundant. In our view that cannot be an ideal situation in the eyes of law. Thus, in our considered opinion, after taken into account this Press Note, the aforesaid controversy comes to rest. The aforesaid notification was not brought to notice of Tribunal in assessment year 2011-12 and that is why decision was given by the Tribunal accordingly. Further, both the parties unanimously agreed that this Press Note has brought out clarity in the legal

It is further brought to our notice that this issue is no more res-integra as the same has been threadbare discussed, analyzed and decided by Hon’ble Delhi High Court and few other courts of the country.

In the case of Nestle India Ltd. (supra), Hon’ble Delhi High Court observe as under:- “We take up question of law No. 2 in the first instance. We are of the view that the Tribunal is not correct in observing that since the permission is given by the Reserve Bank of India, the reasonableness and genuineness of the expenditure could not have been gone into by the Assessing Officer. The purpose for which such permission is given by the RBI is totally different. The RBI is only concerned with the foreign exchange and, therefore, would look into the matter from that point of view. The RBI, at the time of giving such permission would not keep in mind the provisions of the Income-tax Act and that is the function of the Income-tax authorities and, therefore, they can validly go into such an issue. Thus, we answer question of law No.2 in favour of the revenue and against the assessee but hasten to add that it has no bearing on the 14 A.W Faber Castell outcome of the case as they payment is found to be reasonable and genuine, even otherwise”. (Emphasis supplied in bold) 18. Further, in the case of Oracle India Private Limited, it was inter-alia observed by the Hon’ble Delhi High Court that notification issued by RBI to the said assessee permitting payment of royalty at the rate of 30% of IPP of the Oracle Software Appliances may not be the conclusive factor for the purpose of determination of ‘ALP’ under Transfer Pricing Regulations.

Similarly in the case of Sony Ericsson Mobile Communication India Pvt. Ltd., Hon’ble Delhi High Court observed on this issue as under:- “However, we do not agree with the finding recorded by the Tribunal that as the Government of India had permitted remission of royalty through automatic route, the royalty paid can be per se or conclusively treated as the arm’s length price. Applicable rules authorize remission of royalty upto a particular percentage under automatic route to the foreign collaborators. Authorising remission through automatic route upto a particular percentage, does not reflect examination of arm’s length principle. It would be incorrect to read into the general authorization under the Foreign Exchange Management Act and Rules, an implied adjudication order on the question of quantum or arm’s length price. When specific permission is granted, the issue may acquire a different dimension. We do not express any opinion, when specific permission is relied upon”. (Emphasis supplied in bold) 20. Further, identical issued came up before Mumbai Bench Tribunal in the case of Sara Lee TTK Ltd., (supra) decided this issue as under:- “We have considered the rival submissions and perused the relevant finding given in the impugned orders. We had also deliberated on the judicial pronouncement referred by lower authorities in their respective orders as well as cited by Ld. AR and Learned D. R. during the course of hearing before us, in the context of factual matrix of the case. From the record we found that the assessee did not bench mark the royalty payment separately. On enquiry by TPO, it has relied on RBI approval given in 1995 and also on the fact that the assessee earned a gross profit of 41.6%. TPO applied Press Note 9 (2000 series) and restricted it

It was pointed out by Ld. CIT-DR that FIPB approval relied upon by assessee is actually no specific approval but it merely refers to the rates prescribed under the automatic route prescribed under Press Note No.2 (2003 series) in this regard. Our attention has also been brought to the letter issued to the assessee dated 9 March, 2005 by FIPB unit of Ministry of Finance, wherein, in response to assessee’s application for seeking approval of the royalty payment, the concerned authority has made reference to the automatic route permission for the payment of royalty as per Press Note No.2 (2003 series) i.e. up to 8% on exports and 5% on domestic sale. Thus, firstly it is not specific approval as it merely talks about overall ceiling or maximum rates allowed under the domestic route. Further, the rates referred here were related to payment under technology transfer whereas assessee had admittedly made the payment on account of user of trademark/brand name and not on account of transfer of technology. Therefore, viewed from any angle, these rates were of no relevance or use for determination of ‘ALP’ on per se basis or conclusively.

We have considered overall facts of this case and legal position as discussed above. In our considered opinion also the rates of payment of royalty approved by the RBI or by the FIPB (relying upon the rates allowed by RBI under automatic route) would not become per se or conclusively or ipso- facto ‘ALP’ rates. In our opinion both the legislation operate into different fields. The rates allowed under the automatic route by the RBI or FIPB are meant to achieve objectives in different areas. The whole thrust of the income tax proceedings and transfer pricing regulations is to ensure that taxable profit earned by an entity India are not shifted to foreign tax jurisdiction without

The assessee shall be free to carry out fresh transfer pricing study and independently bench mark its aforesaid international transaction with independent comparables for establishing the payment made by it at Arm’s Length Price. The AO/TPO shall also be free and duty bound to take on record and consider all the evidences as may be brought on record by assessee to justify ‘ALP’ of the impugned transaction. The AO/TPO shall also be free to carry out independent transfer pricing study, if required, as permitted and prescribed under the Transfer Pricing Regulations. Further, the assessee shall be free to file all the evidences as may be needed to support its claim and is also free to raise any legal and factual issue in this regard. The AO/TPO shall

Ground No. 7 and 8:- These grounds deal with the disallowance made by the lower authorities on account of late payment of employees contribution towards provident fund and ESIC aggregating to Rs.12,03,002/-. The brief background is that the disallowance was made by the AO on the ground that employees’ contribution to PF and ESIC was deposited beyond the due date of payment. It was contended by the assessee that entire payment has been made within the financial year itself, thus entire payment due stood deposited before the due date of filing of return.

During the course of hearing, it is brought to our notice that identical issue came up before the Tribunal in assessee’s own case in AY 2011-12 wherein the Tribunal allowed relief to the assessee by observing as under:- “The ground No. 2 relates to the adjustments on account of disallowance of employees’ contribution towards provident fund and ESIC. The Ld. AR, at the outset, has stated that the payment of employees’ contribution towards provident fund & ESIC was made by the assessee before due date of filing of return of income for the year under consideration. He, therefore, has stated that the issue is squarely covered by the decision of the Hon'ble Supreme Court in the case of “CIT” vs. Alom Extrusions Ltd.” reported in (2009) 319 ITR 306 (Supreme Court) Wherein the Hon'ble Supreme Court inter alia has held that the amendment to section 43B vide Finance Act, 2003 w.e.f. 01.04.2004, whereby, the second proviso to section 43B has been deleted and further amendment to 1st proviso has been made, whereby, it has been provided that nothing contained in the said section shall apply in relation to any sum which is actually paid by the assessee on or before the due date applicable for furnishing the return of income, is retrospective in nature

During the course of hearing before us, no distinction was made by Ld. CIT-DR on the legal position. This fact was shown to us that entire payment has been deposited within the financial year 2011-12, as has also been mentioned by the Assessing Officer in the assessment order itself. Under these circumstances, we find that the disallowance made by lower authorities is not sustainable and therefore same is hereby deleted. As a result, Ground No.7 and 8 are allowed.

As a result, appeal of the assessee is partly allowed.