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IN THE HIGH COURT OF KARNATAKA, BENGALURU
DATED THIS THE 2ND DAY OF AUGUST 2018
PRESENT
THE HON’BLE DR.JUSTICE VINEET KOTHARI
AND
THE HON’BLE MRS.JUSTICE S.SUJATHA
I.T.A. No.119/2015
BETWEEN :
THE COMMISSIONER OF INCOME TAX LTU, JSS TOWERS, BSK III STAGE, BANGALORE-560 085.
THE ASST. COMMISSIONER OF INCOME TAX, LTU, JSS TOWERS, BSK III STAGE, BANGALORE-560 085.
...APPELLANTS
(BY SRI K.V.ARAVIND, ADV.) AND :
M/s TOYOTA KIRLOSKAR AUTO PARTS PVT. LTD., PLOT NO.21, BIDADI INDUSTRIES AREA, RAMANAGAR DISTRICT, BANGALORE-562 109, PAN:AABCT5590Q
…RESPONDENT
(BY SRI ANKUR PAI, ADV. FOR SRI K.R.VASUDEVAN, ADV.)
THIS ITA IS FILED UNDER SECTION 260-A OF INCOME TAX ACT 1961, ARISING OUT OF ORDER DATED 22/10/2014 PASSED IN ITA NO.1356/BANG/2011, FOR THE ASSESSMENT YEAR 2007-2008. PRAYING TO 1. FORMULATE THE SUBSTANTIAL QUESTIONS OF LAW STATED ABOVE. 2. ALLOW
Date of Judgment 2-8-2018, ITA No.119/2015 The Commissioner of Income Tax & another Vs. M/s Toyota Kirloskar Auto Parts Pvt. Ltd.
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THE APPEAL AND SET ASIDE THE ORDERS PASSED BY THE ITAT, BANGALORE IN ITA NO.1356/BANG/2011 DATED:22/10/2014 AND CONFIRM THE ORDER OF THE DRP CONFIRMING THE ORDER PASSED BY THE ASST. COMMISSIONER OF INCOME TAX, LTU, BANGALORE.
THIS APPEAL COMING ON FOR HEARING, THIS DAY, S. SUJATHA, J., DELIVERED THE FOLLOWING:
J U D G M E N T
Mr. K.V. Aravind, Adv. for Appellants – Revenue. Mr. Ankur Pai, Adv. for Mr. K.R. Vasudevan, Adv., for Respondent – Assessee.
This Appeal is filed by the Revenue purportedly raising substantial questions of law arising from the Order of the Income Tax Appellate Tribunal, ‘A’ Bench, Bangalore in IT[TP]A No.1356/Bang/2011 dated 22.10.2014, relating to the Assessment Year 2007-08.
This Appeal has been admitted on 01.09.2015 to consider the following substantial questions of law. “1. Whether on the facts and in the circumstances of the case the Tribunal is right in law in remanding the matter back to the AO/TPO to determine the Arms Length Price of royalty by adopting TNMM even when the assessing
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authority has rightly adopted CUP method considering the facts of the case and provisions of the I.T.Act? 2. Whether on the facts and in the circumstances of the case the Tribunal is right in law in remanding the matter back to the AO/TPO for de novo consideration as to whether the items in the stock are spare parts or various components of the spare parts and directing the assessing authority to allow them as provision if found to spare parts even when the assessing authority had rightly disallowed the provision made for slow moving inventory which the assessee claimed as write off of spare parts of the model ‘qualis’ the manufacture of which was discontinued?”
Regarding Substantial Question of law No.2:
The findings recorded by the learned Tribunal on this issue are quoted hereunder: “17. The second disallowance against which the assessee is aggrieved is the disallowance of provision for slow/non-moving inventories. Brief facts relating to this issue are: the assessee had made a provision towards slow/non-moving items. During the assessment
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proceedings, the assessee was asked to furnish the details of such a provision. In response to the same, the assessee replied that the assessee- company carries on various types of inventories such as raw-material, components, stores, work- in-progress, finished goods etc., which are used for the manufacture of Axles and Shafts. It was further submitted that from the internal analysis of the inventory carried on by the assessee as on 31-3-2007, it was found that a significant part of selective fitment parts is redundant in nature, considering the process of tolerance and current rate of consumption. It was submitted that the assessee had discontinued the manufacture of its model ‘Qualis’ and inventories in respect of the slow and non-moving items pertains to the spare parts of Qualis and therefore the assessee had made such a provision. The AO, however, did not accept this contention and held that phasing out of Qualis started only during the earlier assessment years and hence the treatment of stock of spares as dead stock appears to be premature. He, therefore, held that the provision of slow moving inventory written off by the assessee amounting to Rs.2,74,49,000/- is to be added back to the income of the assessee and he accordingly made the addition. This disallowance
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was confirmed by the DRP and the assessee is in appeal before us. 18. The learned counsel for the assessee reiterated the assessee’s submissions whereas the learned departmental representative supported the orders of the authorities below.
Having regard to the rival contentions and the material on record, we find that the contention of the assessee is that the inventory consists of not the spare parts but the items which are used to manufacture the spare parts of Qualis. So, as rightly pointed out by the learned counsel for the assessee, if the vehicle itself is not being manufactured then there would not be any requirement to manufacture the spare parts of such a vehicle and in such an event, stock would be redundant or obsolete. However, it is the contention of the assessee that the stock does not relate to the spare parts, but relates to various components of spare parts. This fact needs verification. We therefore deem it fit and proper to remit this issue also to the file of the AO for de novo consideration as to whether the items in the stock are spare parts or are various components of the spare parts. If they are not found to be spare parts, then such an amount shall be allowed as a provision and the disallowance
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shall only be restricted to the spare parts found to be part of the stock. In the result, this ground of appeal is also treated as allowed for statistical purposes.”
Learned Tribunal has remanded the matter to the Assessing Officer for de novo consideration to examine whether the items in the stock are spare parts or various components of spare parts and if they are found to be various components of spare parts to allow such amount as a provision, this goes to the root of the matter. In view of the remand order made by the Tribunal, to ascertain this aspect of the matter, we do not find any substantial question of law arising for our consideration on this issue. Regarding Substantial Question of law No.1:
The learned Tribunal, after discussing the rival contentions of both the Appellants-Revenue and Respondent-Assessee, has returned findings as under: “12. Having regard to the contentions of both the parties and the material on record, we
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find that the assessee has aggregated all the international transactions entered into by the assessee with its AE to compute the ALP. The contention of the assessee is that the all the transactions are interlinked and therefore the same are aggregated under TNMM. The TPO has, however, held that each transaction has to be analyzed separately and the ALP of the royalty, technical assistance fee and intra-group services are to be computed separately. In the light of the above, the important aspect to be considered is whether the transfer pricing analysis is required to be carried out with respect to tax-payer’s individual international controlled transaction or a group of international controlled transaction having close economic nexus?
As per the Indian Income-Tax Act, ideally, the transfer pricing is to be made on a transaction by transaction basis. However, Rule 10A(d) provides that the term ‘transaction’ includes a number of closely linked transactions. Thus, in cases where separate transactions are so closely linked or are closely inter-related or continuous and where application of the arm’s length principle on a transaction by transaction basis becomes cumbersome for all involved and
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would not lead to an accurate result, recourse is often had to evaluate transactions following an ‘aggregation’ principle. Due to increasing presence of composite contracts and ‘package deals’ in an MNE group, the aggregation of transactions become necessary as a composite contract may contain a number of elements including royalties, leases, sale and licenses all packaged into one deal. One would usually want to consider the deal in its totality to understand how various elements relate to each other, but the components of the composite package deal may or may not, depending on the facts and circumstances of each case, need to be evaluated separately to arrive at the appropriate transfer price. Aggregation issue may also arise when looking at uncontrolled comparables. This is because third party information is not often available at the transaction level. In such circumstances, entity level information is the only recourse available. Therefore, whether ALP- principle is to be applied on a transaction by transaction basis or on an aggregation basis depends on the facts of each case and is not universally or generally applied in all composite contracts involving multiple transactions.
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In the case before us, the assessee has entered into various transactions which include purchase of raw-material, components and consumables, capital assets and payment towards royalty, technical assistance, IT support fee, payment of warranty claims, training fee, reimbursement of expenses etc. It is the case of the assessee that all these transactions are interlinked. However, on perusal of the TP documents filed along with return of income, we find that the payment of royalty is not part of a composite contract/agreement but is on account of a separate Technical Assistance Agreement entered into by the assessee with its AE. The assessee is required to pay the royalty under the Technical Assistance Agreement for use of certain Technical and manufacturing know-how proprietary to Toyota Motor Corporation/Aisin Takaoka Company which is developed by them by virtue of their investment in research and development. The Intangible property in the nature of technical and manufacturing know-how consists of the following: 1. Local content List; 2. Production Drawings; 3. CAD data; 4. Engineering change instructions;
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Toyota Engineering Standards; 6. Sample Parts; 7. Quality Standards; 8. Inspection Standards; (completed products, raw material and work-in- progress); 9. Contents of Part List; ÿ KD Components Part List; 10. Disassembled form Drawings; ÿ Welding & Painting Manual; and 11. Jig arrangement instructions, guage arrangement manual, cutting tool layout drawing, operation drawing and accuracy and precision list.
From the above details, it is seen that the payment of royalty is independent of the purchase of raw materials, components, tools, packing materials, fixed assets etc. The royalty is exclusively towards the use of know-how in the manufacturing process undertaken by the assessee and is therefore not in any way interlinked or inter-connected with other transactions and it would not lead to inaccurate result if it is analyzed separately. In such a situation, we are of the opinion that the contract of payment of royalty can be analyzed separately
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and the such a payment can be determined independently. The ‘L’ bench of the Tribunal at Mumbai, in the case of UCB India(P) Ltd. vs. Ass.CIT, reported in (2009) 121 ITD 131(Mum), held that, when in an enterprise, only similar transactions are undertaken, i.e. all the transactions are of the same type, same class and of similar variety, and the enterprise does not have any other transaction which is not similar, in such a situation, the operating margins of the enterprise would be the TNMM of a class of transactions. In view of the same, we do not see any reason to take a different stand from that of the AO on this issue.
As regards the most appropriate method for determining the ALP of the royalty is concerned, we find that the AO has adopted the CUP method whereas the assessee has adopted the TNM Method. Now, between the two, which is the most appropriate method? Each TP method is suitable only for certain transactions. Under CUP method, higher degree of product similarity and similarity of products generally is required and it will have the greatest effect on the comparability. In addition, because even minor differences in contracted terms or economic conditions could
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materially affect the amount charged in an uncontrolled transaction, Comparability under this method depends on close similarity with respect to these factors or adjustments to account for any differences. Therefore, CUP method is the most direct and reliable method for determination of ALP for the controlled transaction if an uncontrolled transaction has no differences with the controlled transactions that would affect the price or if there are only minor differences that have a definite and reasonably ascertainable effect on price and for which appropriate adjustments can be made. Per contra, Transactional Net Margin Method requires establishing comparability at a broad functional level, such as trading, manufacturing etc. Thus, TNMM requires comparison between net margins derived from the operations of the uncontrolled parties and the net margins derived by an associated enterprise from similar operations. In the case before us, the payment of royalty is for the use of technical know-how by the assessee which is owned by the AEs. The transaction thus involves transfer of intangibles. Such transfers of given intangibles would generally occur between group entities only. Further, each intangible property is unique and not comparable. For these
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reasons, the comparable transactions between independent enterprises for similar intangible may be just non-existent or where available, establishing comparability may pose exceptional difficulties in the absence of availability of all relevant information in public domain. This is more so, because comparability in the transactions of intangibles depend on variety of factors such as – a. Use of intangible in connection with similar product or process within the same general industry or market; b. Similarity in the profit potentials of the intangible. c. Terms of the transfer. d. Stage of development or commercialization of intangibles. e. Rights to receive updates. f. Cross licensing of improvements in intangibles. g. Uniqueness of concerned intangible. h. Duration of license. i. Arrangements for sharing of economic and product liability risks j. Existence of other relationship between parties to the transaction k. Type and nature of functions to be performed by parties
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l. Licensed territory or geography.
Where the asset transferred is an intangible, i.e. it cannot be easily defined, formulated or grossed, it is different from others and therefore finding exactly similar asset and thereby establishing arm’s length price or royalty rate is extremely difficult. Where a MNE group also licenses or transfers the same or a similar intangible to independent enterprises, establishing arm’s length price or royalty rates may not pose many difficulties because CUP method could be applied with appropriate adjustment to account for material differences, if any. However, where comparable uncontrolled transactions are not available, establishing arm’s length price or royalty rate may not be a straight forward exercise and may require a flexible approach that need not be strictly based on specified transfer pricing methods. Therefore, in such a situation, the perfect approach for indirectly bench marking royalty payments is to bench mark the profit margin left in the tested party, after payment of lump sum fee or royalty with the profit margins of comparable uncontrolled companies. The decisions relied upon by the learned counsel for the assessee as
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enumerated in the preceding paragraph No.9 above also support this view. Therefore, we are of the opinion that even if the royalty payment is to be analyzed separately, TNMM is the most appropriate method for determining the ALP.
To demonstrate that the price paid by the assessee towards royalty is at arm’s length, the assessee has filed copies of the agreement of the AE with its other group companies as well where the rates of royalty are the same. Thus, according to the learned counsel for the assessee, the payment is at arm’s length. However, we find that even by adopting the CUP method, the AO has not brought on record any of the comparable companies to arrive at the ALP but has only applied the benefit test to determine the ALP at ‘nil’. The learned counsel for the assessee had stated that the very fact that the assessee has manufactured vehicles using the technical knowhow of the AE demonstrates that the assessee has benefitted from the use of such technology. He submitted that the finding of the AO that the assessee has not been able to establish the benefit derived by it from the use of technical know-how is preposterous as the technical know-how was the essence or the heart
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of the manufacturing process. The fact that the assessee was engaged in the activity of manufacture itself proves the use of technical know-how by the assessee and therefore, as held by the Hon’ble Delhi High Court in the case of EKL Appliances (cited supra), the AO or the TPO cannot question the commercial expediency of the assessee or the quantum of benefit the assessee derived while making the payment. We agree with this contention of the assessee. The Hon’ble Delhi High Court, in the case of EKL Appliances (cited supra), has clearly held that it is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity and also that it is not necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The Hon’ble Delhi High Court further held that the only condition is that the expenditure should have been incurred wholly and exclusively for the purpose of business and nothing more and the quantum of expenditure can no doubt be examined by the TPO as per law in allowing as business expenditure but he has no authority to disallow
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the entire expenditure or part thereof on the ground that the assessee has suffered continuous losses. It was held that so long as expenditure payment has been demonstrated to have been incurred or laid out for the purpose of business, it is no concern of the TPO to disallow the same on any extraneous reasoning and as provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but wholesale disallowance of the expenditure is not contemplated or authorized. Respectfully following the decision of the Hon’ble Delhi High Court, we set aside the finding of the TPO that the ALP of the transaction of royalty is ‘nil’. However, for determining the ALP under the TNMM, the assessee as well as the Revenue have to search for comparable companies. Therefore, we remit this issue to the file of the AO/TPO to determine ALP of royalty by adopting TNMM after giving the assessee a fair opportunity of hearing. This issue is accordingly decided in favour of the assessee for statistical purposes.”
The controversy involved herein is no more res integra in view of the decision of this Court in I.T.A.
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Nos.536/2015 c/w 537/2015 dated 25.06.2018 [Prl. Commissioner of Income Tax & Anr. V/s. M/s.Softbrands India Pvt. Ltd.,] wherein it has been observed that unless the finding of the Tribunal is found ex facie perverse, the Appeal u/s. 260-A of the Act, is not maintainable. The relevant portion of the Judgment is quoted below for ready reference: “Conclusion: 55. A substantial quantum of international trade and transactions depends upon the fair and quick judicial dispensation in such cases. Had it been a case of substantial question of interpretation of provisions of Double Taxation Avoidance Treaties (DTAA), interpretation of provisions of the Income Tax Act or Overriding Effect of the Treaties over the Domestic Legislations or the questions like Treaty Shopping, Base Erosion and Profit Shifting (BEPS), Transfer of Shares in Tax Havens (like in the case of Vodafone etc.), if based on relevant facts, such substantial questions of law could be raised before the High Court under Section 260-A of the Act, the Courts could have embarked upon such exercise of framing and answering such substantial question of law. On
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the other hand, the appeals of the present tenor as to whether the comparables have been rightly picked up or not, Filters for arriving at the correct list of comparables have been rightly applied or not, do not in our considered opinion, give rise to any substantial question of law. 56. We are therefore of the considered opinion that the present appeals filed by the Revenue do not give rise to any substantial question of law and the suggested substantial questions of law do not meet the requirements of Section 260-A of the Act and thus the appeals filed by the Revenue are found to be devoid of merit and the same are liable to be dismissed.
We make it clear that the same yardsticks and parameters will have to be applied, even if such appeals are filed by the Assessees, because, there may be cases where the Tribunal giving its own reasons and findings has found certain comparables to be good comparables to arrive at an ‘Arm’s Length Price’ in the case of the assessees with which the assessees may not be satisfied and have filed such appeals before this Court. Therefore we clarify that mere dissatisfaction with the findings of facts arrived at by the learned Tribunal is not
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at all a sufficient reason to invoke Section 260-A of the Act before this Court. 58. The appeals filed by the Revenue are therefore dismissed with no order as to costs.”
In the circumstances, having heard the learned Counsel appearing for both the parties, We are of the considered opinion that no substantial question of law arises for consideration in the present case.
Hence, the Appeal filed by the Appellants- Revenue is liable to be dismissed and is accordingly dismissed. No costs.
All the pending applications stand disposed of accordingly.
Sd/- JUDGE
Sd/- JUDGE AN/-