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Income Tax Appellate Tribunal, DELHI BENCH ‘I-2’, NEW DELHI
IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH ‘I-2’, NEW DELHI Before Sh. N. K. Saini, AM And Ms. Suchitra Kamble, JM Asstt. Year : 2009-10 Deputy Commissioner of Income Vs M/s Reebok India Co. Tax, Circle-15(1), C.R. Building, 530/1, 3&4, Village Bijwasan, I.P. Estate, New Delhi New Delhi-110061 (APPELLANT) (RESPONDENT) PAN No. AAACR3007K Assessee by : Sh. Ajay Vohra, Sr. Adv. & Neeraj Jain, Adv. Revenue by : Sh. Anand Kedia, CIT DR Date of Hearing : 21.01.2016 Date of Pronouncement : 18.04.2016 ORDER Per N. K. Saini, AM:
This is an appeal by the department against the order dated 30.12.2013 passed by the AO u/s 143(3) r.w.s. 144C of the Income Tax Act, 1961 (hereinafter referred to as the Act).
Following grounds have been raised in this appeal:
“1. On the facts & in the circumstances of the case and in law, the Hon'ble DRP has erred in deleting the addition of Rs.27,23,56,415/- on account of Royalty payments to its Associate Enterprise(AE).
Reebok India Co.
2. On the facts and circumstances of the case and in law, Hon'ble DRP has erred in deleting the above addition on account of Royalty payments to its Associate Enterprise (AE) by taking the basis of decision of Hon'ble ITAT order dated 14.06.2013 in the case of assessee company's own case in AY 2008-09 ignoring the fact that revenue has filed the appeal before Hon'ble Delhi High Court against that order and hence the issue has not attained its finality.
The appellant craves to be allowed to add any fresh grounds of appeal
and/or delete or amend any of the grounds of appeal.”
3. From the above grounds it is gathered that the only grievance of the department relates to the direction given by the DRP to the AO to delete the addition on account of royalty payments to its Associate Enterprises.
Facts of the case in brief are that the assessee, e-filed its return of income on 29.09.2009 declaring an income of Rs.33,09,55,026/-, which was processed u/s 143(1) of the Act. Later on, the case was selected for scrutiny. The AO during the course of assessment proceedings noticed that the assessee had entered into following international transactions with its Associate Enterprises (AE):
Reebok India Co. S.No. International Transactions Method Value in transaction Selected (in Rs.) 1.. Payment of royalty CUP 26,07,11,584/- 2. Import of Finished RPM 32,02,06,380/- Product for Resale 3. Reimbursement of 45,85,355/- Expenses by associated - enterprises 4. Reimbursement of 34,10,389/- Expenses to associated - enterprises 5. Reimbursement of CPM 1,01,84,107/- Expenses to associated enterprises of Global IT and Support Services 6. Purchase of Global IT and CPM 45,44,196/- Support Services by ASL & AAG Total 60,36,42,011/-
The AO referred the matter to the TPO u/s 92CA(1) of the Act. Thereafter the TPO recommended following adjustments:
Particulars Amount (In Rs.) Value of Gross Sales 6,09,08 27,239/- AMP/Sales of the Comparables 0.74% Reebok India Co. Amount that represents bright line 4,50,72,121/- Expenditure on AMP by assessee 65,97,03,403/- Expenditure in excess of bright line 61,46,31,282/- Mark-up at 15.46% 9,50,21,996/- Reimbursement that assessee 70,96,53,278/- should have received Reimbursement actually received 43,84,939/- Adjustment to assessee's income 70,52,68,339/-
The AO also recommended upward adjustment of Rs.27,23,56,415/- on account of payment of royalty. Thereafter the AO passed the draft assessment order by making the adjustment advised by the TPO. The assessee filed objection to the draft assessment order before the DRP who observed in para 3.1 and 3.2 of the order dated 31.08.2013 as under:
3.1 As these grounds are interrelated they are taken up together for adjudication. Assessee had used CUP as the method for the benchmarking these international transactions. However, the CUP data presented before the TPO were transactions between AE and not between unrelated parties. Therefore, TPO issued a show cause notice dated 31.10.2012. Assessee replied to the show cause notice and after examination of the reply, the TPO has come to the conclusion that the CUP can only be used when there is complete identity between the controlled and uncontrolled Reebok India Co. transactions being compared. The TPO has come to the conclusion that taxpayer did not produce any evidence on how the royalty rates are fixed, The taxpayer also did not produce cost benefit analysis at the time of entering into the agreement, TPO has also concluded that the assessee failed to show that it derived any economic benefit from the so called know how and failed to provide the prevailing royalty rates in the similar transaction in uncontrolled situation. 3.2 This issue was litigated at the level of ITAT for the AY 2008-09- in that year also. TPO had disallowed the payment of royalty treating the ALP of the international transaction as nil" The Hon'ble ITAT in its order dated 14.06 2013 (1TA No. 5857/Del/2012) has held that the royalty payment is justified. The basis of the order of the ITAT is mainly on account of the CUP data of similar transactions. It should be kept in mind that the payment of royalty is under the same agreement as it was before the Hon'ble ITAT for the AY 2008- 09.”
The AO by considering the direction of the DRP did not make any adjustment on account of royalty payment.
Now the department is in appeal. The ld. DR relied upon the observations of the TPO and submitted that the AO ought to have made the addition of Rs.27,33,56,415/- on account of payment of royalty.
Reebok India Co.
In his rival submissions the ld. Counsel for the assessee at the very outset stated that the Hon’ble jurisdictional High Court has settled this issue in favour of the assessee in & 213/2014 for the assessment year 2008-09 in assessee’s own case. A reference was made to page nos. 6 to 9 of the assessee’s paper book wherein the issue relating to arm’s length price of royalty has been discussed in para 179 onwards and in para 197 of the said order, the view taken by the ITAT in ITA No. 5857/Del/2012 for the assessment year 2008-09 in assessee’s own case has been approved. A reference was also made to page nos. 54 to 59 of the assessee’s paper book and our attention was drawn towards paras 14.7 to 15 of the said order passed by the ITAT for the assessment year 2008- 09.
We have considered the submissions of both the parties and carefully gone through the material available on the record. It is noticed that a similar issue was subject matter of the assessee’s appeal for the preceding assessment year in which has been adjudicated by the ITAT Delhi Bench ‘I’, New Delhi vide order dated 14.06.2013 and the relevant findings have been given in para 14.7 to 15 of the said order which read as under:
Reebok India Co. “14.7 We find that in this case the assessee has made the payment of royalty amounting to Rs. 152877527/- to the AE. In the Transfer Pricing Report the transfer of royalty was benchmarked using the CUP method as the most appropriate method. The TPO was of the opinion that there was no need of payment of any royalty to the AE in this regard. The TPO observed that approval of the Ministry of Commerce, Department of Industrial, Policy and Promotion cannot be treated as a valid CUP as required by Rule 10B(1)(a) of the I.T. Rules. TPO has observed that the assessee was asked to furnish the information as to the cost benefit analysis with regard to the payment of royalty. TPO noted that no such cost benefit analysis was carried out by the Assessee. TPO has further referred that assessee has not submitted the comparable instances. TPO further noted that though there has been increase in the assessee’s sales there has been decline in the net profit to sales ratio. On the basis of above, TPO did not accept the contention of the assessee that superiority of technology received by the assessee on payment of royalty was giving commercial benefits. TPO opined that payment of royalty by the assessee to the AE did not bring any commensurate benefit. TPO further observed that in an arms’ length situation, no independent enterprise would make payment for royalty for technology which is not contributing to its profitability. 14.8 We find that as per Clause 1 of the Technology License Agreement dated 01.10.2002 between Reebok International ltd. and Reebok India Company, the assessee has been provided Reebok India Co. data, documentation, drawings and specifications relating to inventions, designs, formulae, process and similar property, referred to as know-how. Clause 2 of the same agreement, grants the assessee non exclusive, non transferrable right to utilize the technology in the manufacture and distribution of Reebok Products in India. We find that assessee gets goods manufactured on the basis of technology technical know and designs provided by the AEs. In consideration of provision of technology and know-how, the assessee pays royalty @ 5%. The industry in which the assessee operates i.e. the premium sports apparel and footwear industry is highly competitive and in order to survive and grow profitably it is imperative for the assessee to continuously launch new and improved products in the market. 14.9 Assessee does not undertake any significant research and development activity on its own and totally depends upon the associated enterprise for provision of technology. The new products are designed and developed largely in the US based Research and Development and product creation centre of the AE. The assessee regularly access this Tech Packages for use in local development and manufacturing processes for the footwear and apparel styles manufactured locally in India which is largely the adaptations of the globally developed styles. The aforesaid technology has been patently by the AEs and therefore, cannot be used without the permission of the AE. Thus, we agree with the submissions of the assessee that entire business of the assessee depends upon the technology provided by the AE and without the Reebok India Co. license to use such technology, the assessee would not be able to continue this business. 14.10 Further the premium value of the product allows the assessee to increase the sales and charge higher price which the leads to higher profitability. It would also be noted that during the relevant previous year the total revenue of the assessee increased to Rs. 451.97 crores from Rs. 360.95 crores in the preceding previous year registering a growth of 25.21%. The growth in the revenue of the assessee clearly demonstrates the benefits derived by the assessee from the use of technology. In this regard, Assessing Officer has observed that since there is a fall in the net profit by sales ratio in the relevant previous year as compared to the preceding previous year. This ratio for financial year 2007-08 was 7.4% as against 8.96% in financial year 2006-07. On the strength of these figures Assessing Officer had made a bizarre conclusion that assessee was not deriving any commercial benefit from the payment of royalty and that payment of royalty by the assessee to the AE did not bring any commensurate benefit. In our considered opinion, on the facts and circumstances of the case, the above conclusion by the Assessing Officer is totally unsustainable. It has been clearly demonstrated that the very survival of the assessee in the industry depend upon the licence and technology & know how provided by the AE. There has been a considerable increase in the sales figures. The growth in the revenue of the assessee clearly demonstrates the benefits derived by the assessee from the use of technology.
Reebok India Co. 14.11 In this regard, assessee’s submission are note worthy that profitability of the assessee can be lower due to various business reasons and the lower profitability in the current year as compared to previous year cannot form the basis for arriving at a conclusion that no benefits were derived by the assessee. It has been submitted that the profit during the current year were lower on account of substantial provision of bad debt, high rent and increase in legal cost. These averments have not been disputed by the Revenue. Accordingly, the inference drawn by the TPO that no benefits were derived by the assessee for use of technology and technical know-how is not tenable. 14.12 We further agree with the contention of the assessee that assessee is free to conduct business in the manner that assessee deems fit and the commercial and business expediency of incurring any expenditure is to be seen from the assessee’s point of view. We find that it is a settled law that the Revenue cannot sit into the shoe of the assessee and decide what is prudent for the business. In this regard, we place reliance upon the decision of the Hon’ble Apex Court in the case of CIT, Bombay Vs. Walchand and Co. Private Ltd. in 65 ITR 381, wherein it was held that "in applying the test of commercial expediency for determining whether an expenditure was wholly and exclusively for business, the expenditure has to be adjudged from the point of view of the businessman and not of revenue". 14.13 We further note that it is on the basis of the same agreement the royalty was paid in earlier Reebok India Co. years. In earlier years the payment of royalty has not been held to be non-bonafide expenditure by the TPO. On thesebasis also the TPO’s conclusion that there is no benefit to the assessee from the payment of royalty is unsustainable. In view of the foregoing discussions, we hold that payment of royalty in this case satisfies the benefit test. The benefit is undoubtedly tangible and it not passive as argued by the Ld. Departmental Representative. 14.14 Furthermore, assessee has duly submitted comparable instances to bench mark royalty as under:- (i) Instances of royalty paid by third party licensees/ distributors (ii) Agreement between Double D’Import S.A.R.I (France) with Adidas International for payment of royalty @ 12% (iii) Agreement of sportsvision with Adidas international for payment of royalty @ 10% (iv) Agreement of Molten Corporation Japan with Adidas International Marketing BV for payment of royalty @ 12% 14.15 Thus, the observation of the TPO that comparable instances were not given by the assessee does not hold water any more. We find that the case laws relied upon by the DR have been cogently rebutted in the assessee’s submissions and rejoinder as above. 14.16 We further find that assessee has sought to justify the payment of the royalty on the basis that in the case of the assessee the concerned Ministry Reebok India Co. of Government Of India has scrutinized the payment of royalty and granted the approval, the payment cannot be regarded as non-bonafide so as to hold the arms length price thereof as NIL. In this regard, we agree that though it is not a conclusive proof, the above approval of the Government has to be given consideration while considering the arms length price of the transaction. Admittedly, in this case assessee has been granted due permission from the concerned Ministry of Government in this regard. 14.17 We are further in agreement with the ld. Counsel of the assessee that Rule 10B(1) states that for the purpose of section 92C(2) the arms length price shall be determined by one of the five methods which is found to be most appropriate method and goes on to lay down the manner of determination of the ALP under each method. The five methods recognized by the rule are (i) comparable uncontrolled price method (CUP), (ii) re-sale price method, (iii) cost plus method, (iv) profit split method and (v) transactional net marginal method (TNMM). The assessee has rightly considered the comparable uncontrolled price method for determining the arms length price. In this context, the conclusion of the TPO that the arms length price of the royalty payment should be NIL without specifying any cogent basis is not sustainable. The TPO’s determination is on the basis of assumption and surmises. Hence, the adjustment made by the TPO is liable to be deleted.
In the background of the aforesaid discussion, we hold that the upward adjustment of Reebok India Co. Rs. 15,28,77,527/- on account of payment of royalty cannot be sustained. Accordingly, we hold that payment of royalty in this case was fully justified.”
The aforesaid order passed by the ITAT was challenged by the department in the Hon’ble Jurisdictional High Court wherein the relevant discussion has been made in paras 179 to 191 of the order dated 16.03.2015 and the conclusion has been drawn in para 197 of the said order which read as under:
“179. We now proceed to examine and answer, the question raised by the Revenue in the appeal filed against Reebok India Company Ltd.
Royalty of Rs.15,28,77,527/- paid to Reebok International Ltd., U.K., was benchmarked by the assessee using CUP Method as the most appropriate method. Royalty paid by Sierra Industrial Enterprises Pvt. Ltd. to Nike International Ltd. USA @ 5% was taken as a valid comparable. In addition, the assessee relied upon Foreign Exchange Management (Current Account Transactions) Rules. 2000 authorising remission of royalty of upto 5% on domestic sales and upto 8% on exports under the automatic route to foreign technical collaborators. The TPO rejecting the claim, observed that the assessee had not established cost-benefit analysis for payment of royalty. No such exercise had been carried out. The TPO referred to technology licence agreement Reebok India Co. dated 1st October, 2002 between the assessee and Reebok International Ltd., U.K. for providing data, documentation, drawings and specifications relating to inventions, designs, formulae, processes and similar properties, referred to as know-how and the non-exclusive, non-transferable right granted to utilize the technology lo manufacture and distribute Reebok products in India. He referred to the profitability data of the assessed and observed that the technology and payment of royalty was not reflected in the profit margins or commensurate benefit. He, therefore, came to the conclusion that no independent enterprise would make payments for royalty which were not contributing to its profitability. The profitability data relied upon by the Assessing Officer reads as under: F.Ys. 2005-06 2006-07 2007-08 Sales (WSP) 252.5 366.2 451.23 Royalty 6.82 9.62 15.29 Net Profit 17.76 32.81 33.34 Net Profit/Sales 7.03% 8.96% 7.4% 181. The TPO accordingly determined the arm's length price of royally as ‘NIL’ in place on Rs.l5,28,77,527/- under CUP Method. The DRP affirmed the action of the TPO and consequently, an assessment order holding that the arm's length price of the royalty was ‘NIL’, in place of controlled transaction value of Rs. 15,28,77,527/-, was passed.
The Tribunal in the impugned order while allowing the appeal" has referred to the technology Reebok India Co. and know-how furnished in the form of 'PUMP' technology. 'DMX' technology and '3D Ultralite' technology. New products were designed and developed after research and development at the Research & Development and Product Creation Centre in Canton, USA. These patented technologies were used in local development and manufacturing process for footwear and apparels. The entire business of the assessee in India was dependent upon the patented technology provided by the AB which could not have been used without licence/permission. Total revenue of the assessed had increased to Rs.451.97 crores from Rs.360.95 crores in the previous year, registering a growth of 25.21%. The technology was required to survive and grow in a competitive industry where continuous innovation was a pre-requisite. The Tribunal observed that payment of royally was treated as a bona fide expenditure in the earlier years and it was an undisputed position that know- how or technical information had been provided under the licence agreement.
On the question whether the royalty should have been paid or not, we are in agreement with the finding of the Tribunal that question of payment of royalty cannot be determined on the basis of profitability or earnings of the assessed, once it is accepted that know-how and technical information was provided. It is not alleged or the case of the Revenue that the technology or know-how was hopeless and useless. The finding of the Assessing Officer/TPO, that the assessee had not derived any commercial benefit as technology and know-how had not resulted in any substantial profit increase, Reebok India Co. has been rightly rejected as totally unsustainable. Profitability of the assessed could have been lower or varied due to various reasons and lower profitability in one or more years cannot lead to the conclusion that no benefits were derived or technology was unproductive. The justification given by the assessee for lower profits on account of bad debts, high rent, increase in legal cost stand highlighted and accepted by the Tribunal.
Transfer pricing provisions as noted above, recognise separate entity principle. Therefore, as a sequitur, it follows that the AE is a separate entity and when it avails and secures advantage of technical know-how, it should pay arm's length price for the right to use. The arm's length price would be the fair-market price of the technical know-how, which is licensed.
Royalty payable for availing the right to use would depend upon corresponding price, which would have been paid by an independent or unrelated enterprise. This is judged by applying comparables. TPO has not rejected the quantum of royally on the said principle. The reasoning given by the TPO is not only erroneous for the reasons stated above, but is also contrary to the Rules. Depending upon the method selected, net profit or gross profit of the assessed has to be compared with profit margins of related enterprise. The formula-prescribed under the Rules does not accept the ratiocination adopted and applied by the TPO.
A similar controversy had arisen before the Delhi High Court in EKL Appliances Limited, (supra). The assessed in the said case was Reebok India Co. incurring losses and on this pretext, the TPO had disallowed the entire brand fee or royalty. The Tribunal disagreed with the Revenue. The appeal filed by the Revenue was dismissed stating that the considerations relied by the TPO were irrelevant considerations for the purpose of Rule 10B. The Division Bench of this Court rejected the argument that financial health of the assessee alone would determine whether or not the transfer price paid was appropriate and the fair-market value. This would be an extraneous consideration for disallowing the whole expenditure, when technology was required and provided. Opinion of the assessed matters. The transfer pricing regulations permit examination of the international transaction and suitable adjustments. It would be a different matter if it is established that an independent entity, in the given prevailing circumstances, would not have entered into the said transaction with the AE. This is not the case set up by the Revenue. The assessed in the present ease has made profits.
The Tribunal in the impugned order, therefore, had rightly applied the test of commercial expediency and has recorded that the assessed was free to conduct business in the manner it deems fit. We hasten to add that two exceptions have been carved out in the case of EKL Appliances Limited (supra), but the exceptions have not been invoked, nor are the conditions satisfied.
Importantly, the assessee had benchmarked royalty with instances of royally paid by third Reebok India Co. party licensee/distributors and had relied upon the three agreements, which were quoted as compatibles. As per the comparables, the royalty paid was between 10-12% and they are:- “(ii) Agreement between Double D’Import S.A.R.I (France) with Adidas International for payment of royalty @ 12%. (iii) Agreement of Sportsvision with Adidas international for payment of royalty @ 10%. (iv) Agreement of Molten Corporation Japan with Adidas International Marketing BV for payment of royalty @ 12%,"
The Tribunal has noted with disapproval the observation of the TPO that comparable instances were not given, observing that this was factually incorrect.
However, 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 royally paid can be per se or conclusively treated as the arm's length price. Applicable rules authorise 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 authorisation 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 Reebok India Co. dimension. We do not express any opinion, when specific permission is relied upon.
The fact that royalty has been paid would be a relevant consideration and factum, when we consider arm's length price of the international transaction of distribution and marketing. Tax treatment of royally payments being different, the royally transaction, therefore, may be benchmarked separately. However, payment of royalty even if justified and appropriate on applying arm's length principle, can be a relevant factor when the question of compensation of the domestic AC for undertaking distribution and marketing functions arises for consideration.
The following substantial question of law is raised: “Whether Income Tax Appellate Tribunal was right in setting aside/deleting transfer pricing adjustment made on account of payment of royalty to an associated enterprise?” In view the discussion under the heading Q, the substantial question of law is answered against the Revenue and in favour of the assessee.”
We, therefore, in view of the ratio laid down by the Hon’ble Jurisdictional High Court in assessee’s own case vide order dated 16.03.2015 in do not see any merit in this appeal of the department.
Reebok India Co. 13. In the result, appeal of the department is dismissed. (Order Pronounced in the Court on18/04/2016)