PRAXAIR INDIA PRIVATE LIMITED,BANGALORE vs. ACIT, BANGALORE

Per INTURI RAMA RAO, AM :

IT(TP)A No.23/Bang/2012 Page 2 of 17 2. The assessee raised the following grounds of appeal:

I. Transfer Pricing Adjustment 1. The Honourable DRP, the Ld. AO and the Ld. TPO have erred in determining the Arm's Length Price [ALP] of the royalty payment to be NIL, and thereby making the transfer pricing adjustment of Rs. 32,918,381.

IT(TP)A No.23/Bang/2012 Page 3 of 17 3. Further the Honourable DRP, the Ld. AO and the Ld. TPO erred in: a. In disregarding the legally binding agreement entered between the appellant and its AEs pertaining to payment of royalty without assigning any cogent reasons; b. Concluding that no economic value was derived and that no tangible and commercial benefit was received by the assessee on the payment of Royalty; c. Ignoring the fact that the economic value derived is also relation to in the nature of increased visibility in the market, increased demand for the products of the appellant in India, and attaining stability and reliability in the market; d. In not taking into cognizance the additional documentation support submitted along with the above ground of objection as the proof of tangible and commercial benefit received by the assessee from the associated enterprise [AE].

4. The Honourable DRP, the Ld. AO and the Ld. TPO ought to have appreciated the following: a. The fact that the transactions pertaining to payment of royalty cannot be tested in isolation as the same is interlinked to the primary manufacturing operations of the appellant; b. The fact the manufacturing technology [i.e. supply system technologies and applications technologies to manufacture and sell the industrial gases] and related support is indispensable for the manufacturing process of the assessee and this technology and related support facilities and resources is only available with the associated enterprise [AE]; c. The "benefit test" documentation proof as provided by the assessee, in support of benefit received from the AE in the form of technical, operational, maintenance, quality assurance, application support and safety support;

IT(TP)A No.23/Bang/2012 Page 4 of 17 d. The benefit derived by the appellant in using the global brand name of its Parent i.e. "Praxair" to bid for contracts, avail loans from the banks, increase the presence in domestic market, etc. 5. The appellant craves leave to add, to alter or amend all or any of the afore-stated grounds of appeal

. II. Corporate Tax Brought forward unabsorbed depreciation

1. The learned Assessing Officer and the Honourable DRP have erred in setting off brought forward unabsorbed depreciation pertaining to Assessment Year 1997-98 amounting to Rs 33,060,114 instead of the eligible sum of Rs 36,834,436.

Carry forward of unabsorbed depreciation 2. The learned Assessing Officer and the Honourable DRP have erred in computing the amount of unabsorbed depreciation to be carried forward to future assessment years at Rs.,17 1,544,189,037 instead of Rs. 1,919,416,420 claimed in the return of income.

3.1 After noticing the above, the AO made a reference u/s 92CA to the Transfer Pricing Officer (TPO) for determination of arms’ length price (ALP) in respect of above reported international transactions. The TPO had accepted that above international transactions except royalty payment of Rs.3,29,18,381/- paid to its AE Praxair Technology Inc., USA are at arm’s length and after analyzing the terms of royalty agreement, the TPO concluded that the transactions of royalty should be analyzed separately. After calling for information from the assessee-company, the TPO analyzed the entire payment of royalty and held that the assessee-company had not got any tangible commercial benefit in terms of improved probability even after paying technical know- how and therefore, he inferred that payments are only made to IT(TP)A No.23/Bang/2012 Page 6 of 17 siphon off profits from India with minimum incidence of tax. He finally concluded as follows:

“5.5 Summary To sum up, the ALP of the royalty payments by the taxpayer for use of know how is determined at nil because:

1. 1. The taxpayer did not produce any evidence / documentation on how the royalty rate fixed. At an arm's length, party receiving technology would like to see the profitability from future revenue streams before fixing a royalty rate.

2. The taxpayer did not produce any cash flow study at the time of entering into technical assistance agreement with its AE showing that the royalty rate is not fixed based on expected benefit.

3. There is no proof that the other group concerns or third parties are also charged identical royalty.

4. The taxpayer has also not been able to show that it derived any economic benefit from the alleged know how received the AE.

5. The profit that accrues to the licensee may not arise solely through the engine of the technology. There are returns from the mix of assets it employs such as fixed and working capital and the returns from intangible assets such as distribution systems, trained workforce, etc. Allowances need to be made for them. In the absence of any data provided by the taxpayer, it is impossible to know what percentage of profits the licensee would like to share at an arm’s length after removing the returns from assets employed and other economic factors which may not arise solely through the engine of the technology.

6. The taxpayer did not give the details of royalty rates in the industry.

IT(TP)A No.23/Bang/2012 Page 7 of 17 Thus the arm's length price of royalty is determined at Rs. Nil. a. Payment of Royalty Rs. 3,29,18,381/ b. Arm’s length price under CUP Rs. NIL c. Adjustment U/s 92CA Rs. 3,29,18,381/- The above amount of Rs 3,29,18,381/- is treated as adjustments U/s 92CA as the value of royalty transactions in uncontrolled conditions is treated as Rs. Nil under CUP and in the absence of any substantiation to show that substantial benefit is accrued to the taxpayer. Thus the above amount of Rs. 3,29,18,381/ is treated as transfer pricing adjustment for the FY 2006-07.”

3.2 Thus, the TPO determined ALP of royalty payment at nil and accordingly, he suggested adjustment u/s 92CA of Rs.3,29,18,381/-. The AO has passed the draft assessment order dated 28/12/2010 after making TP adjustment as suggested by the TPO of Rs.3,29,18,381/-.

IT(TP)A No.23/Bang/2012 Page 8 of 17 5.1 Learned counsel for the assessee submitted that the transaction of royalty should be aggregated with the total manufacturing cost of the assessee-company and in any event, after payment of royalty the net margin earned by assessee- company for the year under consideration is 18.15% as against profit earned by comparable company in the same business of 13.42%. In any event, he submitted that in view of the decision of the Hon’ble Delhi High Court in the case of EKL Appliances (24 taxmann.com 199) the criteria of benefit test is no longer relevant to decide the ALP of transaction and it is no longer necessary to establish that expenditure has resulted in profit or income either in the same year or in any of the subsequent years. In support of this proposition, he relied on the following judgments: i. CIT vs. EKL Appliances (24 taxmnn.199); ii. DCIT vs. Air Liquide Engg. India Pvt.Ltd.(2014) 52 taxmann.171 (Hyd); and iii. SC Enviro Agro India Pvt. Ltd. Vs. DCIT (2013) 33 taxmann.com 261 (Mum)

Learned counsel for assessee also filed copies of agreements in support of royalty payment. He further submitted that royalty paid is less than 5% of the sale which is also approved by the Reserve Bank of India. Therefore, he submitted that payment of royalty to its AEs is at arm’s length and does not require any adjustment.

IT(TP)A No.23/Bang/2012 Page 9 of 17 5.2 On the other hand, ld.CIT(DR) relied on the orders of the lower authorities.

5.3 We heard rival submissions and perused material on record. First we deal with the contention of the assessee that transaction payment of royalty should be aggregated with all international transaction and should be computed by following TNMM. The principle of aggregation are laid down in rule 10A(d) of the IT Rules. The circumstances in which transaction should be aggregated are laid down in rule 10A(d) of the IT Rules which are as follows:

“10A. For the purposes of this rule and rules 10AB to 10E,— .....................................................

(d) ‘transaction includes a number of closely linked transactions.

5.4 The only contention urged by the learned counsel for assessee is that royalty forms part of the manufacturing cost and royalty expenditure is very minimum and therefore should be aggregated. This is not one of the circumstances envisaged under the provisions of rule 10A(d) of the Rules. Furthermore Special Bench of the Tribunal in the case of L.G.Electronics India (P) Ltd. vs. ACIT (153 ITD 591) vide para.8.3 held that international transaction of royalty payment is a separate transaction and not closely linked with other transactions. Therefore, cannot be mixed with other transactions for the IT(TP)A No.23/Bang/2012 Page 10 of 17 purpose of determination of ALP at the entity level under TNMM cannot be allowed. Even the Hon’ble Delhi High Court in the case of Sony Ericson Mobile Communication India (P) Ltd. Vs. CIT (374 ITR 118) held that only closely linked transactions can be aggregated but transactions which are not closely related to each other would require determination in a segregate manner. The Delhi bench of Tribunal held in the case of Gurner India (P) Ltd. Vs. DCIT (70 taxmann.com 240) as follows:

“5.5 When we consider the ratio decidendi of the above referred two judgments, the picture which emerges is that although closely related transactions can be aggregated, but, unrelated transactions cannot be clubbed for determining ALP on a combined basis. The relevant criteria to determine whether certain transactions be considered as one international transaction or not is to see if such transactions were entered into a package deal or were intended to be simultaneously accepted or these are so closely linked that one cannot at all stand without the other. If the above criteria is satisfied, then, two or more related transactions can be considered as one international transaction for the purpose of determining their ALP. On the contrary, if the above criteria is not satisfied, then, these transactions are to be viewed separate from each other and, accordingly, their ALP should also be determined in a distinct manner as if these are two separate independent transactions. The mere fact that both the intra-group services and goods are utilized by the assessee for the manufacture of the final product, cannot be treated decisive to consider such separate transactions as a single transaction. 5.6 Adverting to the facts of the instant case, we find that that the assessee entered into an Agreement with its AE, namely, Gruner AG, a German company, on 6th of March, 2009, a copy of which has been placed on pages 167 onwards of the paper book. Under this Agreement, the assessee was granted a licence permitting use of technology and technical know-how in the field of electro mechanical components and also the brand name of its foreign AE. In lieu of such use of technical know-how and brand name, the assessee became liable to pay a licence fees and royalty as stated in Schedule II to this Agreement. This Schedule provides for payment of royalty and fees for technical services

IT(TP)A No.23/Bang/2012 Page 11 of 17 each @ 8% calculated on the basis of the net ex-factory sale price of the product, exclusive of excise duty minus the cost of the standard bought out components and the landed cost of imported components, irrespective of the source of procurement, including ocean freight, insurance, custom duties, etc. Apart from this Agreement, the assessee also entered into another Agreement dated 25.6.2009 with Gruner AG, Germany, for availing certain Management services. A copy of such Agreement is available on page 107 onwards of the paper book. Under this Agreement, the assessee agreed to pay at the hourly rates. It is the payment pursuant to the Agreement dated 25.6.2009 and 8% fees for technical services under the Agreement dated 6.3.2009, that the assessee paid total fees for technical services at Rs. 4.72 crore. Royalty payment @ 8% made to Gruner AG, under the Agreement dated 6.3.2009, stands at Rs. 3.24 crore. Thus it is palpable that the assessee paid royalty and fees for technical services to its AE pursuant to the Agreements which are solely for this purpose. There is no reference or mention whatsoever of any other international transactions undertaken by the assessee during the year in these Agreements. It is further found that the international transactions of import of raw material and export of finished goods along with lease of machine/tools and purchase of plant and machinery, etc., have no link with payment of royalty and payment of fees for technical services. The two international transactions of payment of royalty and fees for technical services are altogether independent from the international transactions of import of raw materials, etc. The ld. AR vehemently harped on the fact that royalty and fees for technical services was paid by the assessee on the basis of import of raw material and, hence, these transactions should be considered along with the other international transactions including import of raw materials, spares and consumables. We are afraid that this contention is not correct. We have discussed hereinabove that the Agreement dated 6.3.2009 provides for payment of royalty and fees for technical services: 'calculated on the basis of the net ex-factory sale price of the product, exclusive of excise duty minus the cost of the standard bought out components and the landed cost of imported components, irrespective of the source of procurement, including ocean freight, insurance, custom duties, etc.' Thus, it is manifest that royalty and fees for technical services is payable by the assessee on sale price net of excise duty and import of raw material, etc. To put it simply, such payment of royalty and fees for technical services @ 8% is only on 'value addition'. There may be total import of goods worth Rs. 100/-. However, royalty and fees for technical services will be paid only on the sale price of goods as reduced, inter alia, by import of the corresponding raw materials, etc. If,

IT(TP)A No.23/Bang/2012 Page 12 of 17 during a particular year, raw material, etc., are consumed worth Rs. 60/-, the remaining Rs. 40/- will be in stock. In such a situation, royalty and fees for technical services will be paid with reference to the amount of sale price as reduced, inter alia, by Rs. 60/-. The essence of the matter is that royalty and fees for technical services is required to be calculated on the basis of ex factory sale price of the goods as reduced by the expenses and not on import of raw materials. It is further pertinent to note that the assessee is not obliged to make 100% purchases and sale to its AEs alone. The assessee is free to purchase raw materials and other components from and also sell its goods to its non-related parties as well. This explicitly proves that the payment of royalty and fees for technical services has relation with the total sales made by the assessee and it cannot be construed as interlinked with import of raw materials from its AE alone. 5.7 It is simple and plain that cross subsidization of the international transactions in a combined approach is impermissible. It is clear from section 92(1) that if an international transaction is recorded showing a lower income than its ALP income, then it is the higher ALP income, which should be considered for the purpose of computation of the total income. Section 92(3) of the Act manifests that the provisions of this section shall not apply in a case where the computation of income having regard to ALP has the effect of reducing income chargeable to tax. The net effect of section 92(3) is that if transacted value income from an international transaction is more than its arm's length price income, then, the ALP income should be discarded and the actual income should be considered. To sum up, it is the higher of actual income or the ALP income from an international transaction, which should to be taken into consideration for computing the total income. It does not mean that the actual more income from one international transaction vis-a-vis its ALP income should be combined with another unrelated transaction which gives actual income less than the ALP income and then both be processed together under this Chapter so as to set off the income (Transacted income minus ALP income) from the first transaction with the potential income arising from the second transaction (ALP income minus transacted value income). When we consider more than one separate transaction under the combined umbrella of TNMM on an entity level, it is quite possible that a probable addition on account of transfer pricing adjustment arising from one international transaction may be usurped by the income from the other international transaction giving higher income on transacted value. That is the reason for which the legislature has provided for determining the ALP of each international transaction separately from the others. As the international

IT(TP)A No.23/Bang/2012 Page 13 of 17 transactions of payment of royalty and fees for technical services are separate transactions and not closely linked with the other transactions with which the assessee has merged them, we cannot permit such merger or aggregation for the purpose of the determining their ALP on entity level under TNMM. We, therefore, reject this contention raised on behalf of the assessee.”

The above decision is squarely applicable in the facts of the present case . Accordingly, we hold that international transaction of payment of royalty is a separate transaction and therefore should be bench marked separately.

5.5 Having held that royalty payment is a separate international transaction, same requires to be bench marked under CUP method. Though royalty cannot be determined at nil by holding that no benefit had accrued to the assessee-company on account of payment of royalty following decision of the Hon’ble Delhi High Court in the case of EKL Appliances (supra) the burden is on the assessee prove that technical services are actually rendered by the AE to the assessee. In identical circumstances, in the case of 3M India Ltd. vs. ACIT, LTU, in & 727/Bang/2011 dated 13/05/2016 it was held by us as under:

“The co-ordinate bench of the Tribunal, to which one of us i.e. the Accountant Member is the author of the order, in the case of M/s.B Fouress Pvt. Ltd. vs. DCIT in dated 30/12/2015 held as follows: ............Thus, the assessee failed to discharge the burden of proving that the expenditure laid out were incurred wholly and exclusively for the purpose of business. We may further add that the Hon’ble Supreme Court in the case of CIT Vs Imperial IT(TP)A No.23/Bang/2012 Page 14 of 17 Chemical Industries (Ind.) Pvt. Ltd (1969) 74 ITR 17 has unequivocally held that the burden of proving that a particular expenditure had been aid out or incurred wholly and exclusively for the purpose of business entirely lies on the assessee. The discharge of the burden had to be effective and meaningful and not to cover up by merely book entries and paper work. The mere fact of payment of commission by account payee cheques and compliances with the TDS provisions shall not alone enable the assessee to claim deduction unless and amount has been expended wholly and exclusively for the purpose of business.

IT(TP)A No.23/Bang/2012 Page 16 of 17 13, The Co-ordinate Bench of Delhi in the case of Printer House Pvt.Ltd. Vs DCIT (Del.) authored by Accountant Member, after referring to the above precedence on this issue held as follows: “Thus, having regard to the ratio laid down in the above cases that in the absence of proof in support of the services rendered by the commission agent, no commission can be allowed as a deduction. Therefore, we dismiss the appeal filed by the assessee and allow the appeals filed by the revenue”.

5.6 Thus, the condition to prove that technical service was actually rendered by the AE to assessee-company is a condition precedent for allowance of the same. The TPO had no occasion to examine this aspect, as the assessee-company had not produced any evidence in support of the technical services rendered. Before us, the assessee-company filed certain evidence in an IT(TP)A No.23/Bang/2012 Page 17 of 17 endeavour to establish that actually technical services were rendered. Therefore, we deem it fit to remit the matter back to the file of the TPO/AO for the purpose of de novo determination of ALP after satisfying himself that the services were actually rendered.