FRIGOGLASS INDIA PVT. LTD.,GURGAON vs. DCIT, NEW DELHI

PER SUDHANSHU SRIVASTAVA, JUDICIAL MEMBER This appeal has been preferred by the assessee against the assessment order dated 27.01.2015 for assessment year 2010-11 passed u/s 143(3) r.w.s. 144C of the Income Tax Act, 1961 (hereinafter called ‘the Act’).

5. Aggrieved by the action of the Assessing Officer, the assessee approached the Disputes Resolution Panel (DRP) and raised the following objections:- “1. The learned TPO erred on the facts and circumstances of the case and in law, by not accepting the economic analysis undertaken by the Assesses which was in accordance with the provisions of the Act read with the Rules for establishing the arm’s length price of the international transactions. 2. The learned TPO erred, on facts and circumstances of the case and in law, in rejecting the combined transaction approach of benchmarking adopted by the Assessee in its transfer pricing documentation and proceeding to determine the ALP of international transactions pertaining to payment of royalty and management fee to its Associated Enterprise (“AE") on a standalone basis by rejecting TNMM as the most appropriate method (“MAM”).in doing so, the learned TPO erred in not considering the transaction by transaction analysis submitted by the Assessee during the assessment proceedings. 3. The learned TPO erred, on facts and circumstances of the case and in law, in arbitrarily selecting Comparable Uncontrolled Price (“CUP") method as the most appropriate method to benchmark the international transaction pertaining to payment of management fee and royalty by the Assessee to its AE. In doing so, the learned TPO has I.T.A. 1906/D/2015 Assessment year: 2010-11 erred in: a) Not undertaken the MAM analysis as prescribed under Rule 10C of the Rules and accordingly not documented the same as prescribed under Rule 10D of the Rules; b) Determining the ALP of the international transaction without following the manner of applying the CUP method prescribed under Rule 10B(1)(a) of the Rules; c) Adopting an ad-hoc and irrational approach to re-compute the ALP of payment of management fee, without establishing the existence of any comparable uncontrolled transactions and demonstrating their comparability with the Assessee; 4. The learned TPO erred, on facts and circumstances of the case and making an adjustment of INR 2,965,700/- to the total income of the Assessee under section 92CA(3) of the Act on account of adjustment in the arm's length price of the international transaction of payment of management fee. In doing so, the learned TPO has erred in: a) Misinterpreted/ misconstrued the facts with respect to the international transactions relating to management fee on the basis of incorrect presumptions. b) Disregarding the Global Transfer Pricing Report justifying the arm’s length nature of the transaction under a transaction-by-transaction analysis.

b) Misinterpreted/ misconstrued the facts with respect to the international transactions relating to payment of royalty on the basis of incorrect presumptions. c) Disregarding the Global Transfer Pricing Report justifying the arm’s length nature of the transaction under a transaction-by-transaction analysis.

I.T.A. 1906/D/2015 Assessment year: 2010-11 6. The learned TPO erred, on facts and circumstances of the case by questioning the commercial rationale of the legitimate business expenses incurred by the Assessee and not restricting the scope of assessment under section 92CA of the Act to determining the ALP of the international transaction by adopting one of the prescribed methods only.

7. The Learned AO has erred on facts and in law in disallowing miscellaneous expenses amounting to INR 855,912 being 5% of the total miscellaneous expenses, on ad- hoc and arbitrary basis alleging that the expenditure incurred by the Assessee is not totally vouched. In doing so, the Ld. AO has failed to bring on record any evidence to demonstrate how the said expense is unreasonable.”

the Transfer Pricing Study (TP Study) of the assessee.

(ii) The DRP concluded that the royalty payment being sent through RBI’s approval at certain rates cannot be equated as payment being at arm’s length and that it cannot be used as Comparable Uncontrolled Price

(CUP). The DRP further held that since the payment for Royalty to AE was a separate international transaction independent of financial results and capable of being verified separately, the TPO was justified in determining the ALP separately rather than I.T.A. 1906/D/2015 Assessment year: 2010-11 aggregating it with other transactions under Transactional Net Margin Method (TNMM). The DRP further held that since the assessee could not substantiate the benefit derived from the payment of royalty, the TPO was justified in holding the ALP for payment of royalty to be at NIL.

(iii) As regards the issue of selection of CUP as the Most

Appropriate Method of TNMM for benchmarking the payments made on account of intra group services and licence fee, the DRP held that since the payment for intergroup services and payment for management fee to AE were separate international transactions, independent of financial results and capable of being verified separately, the TPO was justified in determining the ALP separately rather than aggregating it with other transactions under TNMM.

(iv) As regards the action of the TPO in making an adjustment of Rs. 29,65,700/- on account of adjustment in the ALP of international transactions of payment of management fee, the DRP held that the assessee had made payments for services availed I.T.A. 1906/D/2015 Assessment year: 2010-11 which contained two mark-ups, one by the entity rendering the services and the other by the entity in Greece. Therefore, the second mark-up of 6.5% was rightly to be adjusted in the determination of ALP.

(v) As regards the ad hoc disallowance of 5% of the miscellaneous expenses, the DRP ruled in favour of the assessee and held that since the disallowance was not supported by any evidence, the same had to be deleted.

“1. 1.1. The learned Deputy Commissioner of Income Tax, Circle- 9(2), New Delhi (“the Assessing Officer” or the Ld. AO”)

I.T.A. 1906/D/2015 Assessment year: 2010-11 pursuant to directions of Hon’ble Dispute Resolution Panel (‘Hon’ble DRP’), has erred on facts and circumstances of the case and in law in completing the present assessment at an income of Rs. 18,16,36,630 as against the returned income of Rs. 9,30,49,569 is bad in law. 1.2. That, the Learned Deputy Commissioner of Income Tax, Transfer Pricing Officer -I (5) (hereinafter referred as ‘Ld. TPO’)/ Hon’ble DRP has grossly erred in making/upholding an adjustment of Rs. 8,77,31,148 in respect of payment for management fee and royalty to associated enterprises (“AEs”) and in not appreciating that none of the conditions set out in section 92C(3) of the Act are satisfied in the present case. 2. 2.1. That on the facts and circumstances of the case and in law, Ld. TPO/Hon’ble DRP have erred in not accepting the economic analysis of the Appellant, for determination of the arm's length price (‘ALP’) in connection with the impugned International transactions.

2.2. That the Ld. TPO/ Hon’ble DRP has grossly erred in rejecting the Combined transaction approach of benchmarking adopted by the Appellant in its transfer pricing analysis by selecting Transitional Net Margin Method (“TNMM”) as the most appropriate method (“MAM”) for determining the arms’ length price (“ALP”) of payment of royalty and payment of management fee to its AEs in accordance with the Act, Rules and the generally accepted OECD guidelines. 2.3. The Ld. TPO/ Hon’ble DRP erred in not appreciating that the receipt of various management services, technical know- how and brand usage are closely linked to the overall business activities of the Appellant and erred in analyzing the transaction separately for the determination of ALP. 2.4. The Ld. TPO/ Hon’ble DRP erred in disregarding the Global Transfer Pricing Report justifying the arm’s length nature of the transaction under analysis; I.T.A. 1906/D/2015 Assessment year: 2010-11

3. 3.1. That the Ld. TPO/ Hon’ble DRP erred in not conducting the analysis of selecting the MAM as prescribed under Rule 10C of the Rules and accordingly not documented the same as prescribed under Rule 10D of the Rules. 3.2. The Ld. TPO/ Hon’ble DRP erred in law by upholding the determination of the ALP of the international transaction using Comparable Uncontrolled Price (‘CUP’) method without following the manner of applying the CUP method prescribed under Rule 10B(1)(a) of the Rules. 3.3. The Ld. TPO/ Hon’ble DRP have erred in upholding the adoption of CUP method as the most appropriate method for determining the arm's length price in respect of the impugned international transaction without identifying any comparable uncontrolled transaction(s) for the computation of the ALP as prescribed in Section 92F(ii) of the Act. 4. 4.1. The Ld. TPO/ Hon’ble DRP erred in passing an order that is perverse in law ignoring the relevant submissions, information and documents provided by the Appellant to substantiate the services and benefits received by the appellant in lieu of payment of royalty, and based on a preoccupied mind reached at an inappropriate conclusion that the arm’s length value of the transaction pertaining to payment of royalty should be Nil. 4.2. The Ld. TPO/ Hon’ble DRP erred in misinterpreting/ misconstrued the facts with respect to the international transaction relating to payment of and royalty on the basis of incorrect presumptions and accordingly made an adjustment of INR 84,765,448 to the total income of the Assessee. 4.3. The Ld. TPO/ Hon’ble DRP erred in misinterpreting/ misconstrued the facts with respect to the international transaction relating to payment of management fee on the basis of incorrect presumptions and made an adjustment of of INR 2,965,700/- to the total income of the Assessee. Questioning the commercial rationale of business expenses 5.

I.T.A. 1906/D/2015 Assessment year: 2010-11 The Ld. TPO/ Hon’ble DRP erred in questioning the 6. commercial rationale of the legitimate business expenses incurred by the taxpayer and not restricting the scope of assessment under section 92CA to determining the arm’s length price of the international transaction by adopting one of the prescribed methods only. Disregarding the directions of the Hon’ble DRP.

6.1. The Learned AO has erred on facts and in law in disallowing miscellaneous expenses amounting to INR 855,912 being 5% of the total miscellaneous expenses, on ad-hoc and arbitrary basis alleging that the expenditure incurred by the Assessee is not totally vouched. In doing so, the Ld. AO has failed to bring on record any evidence to demonstrate how the said expense is unreasonable. Without prejudice, the Ld. AO has further erred in disallowing 5% of the miscellaneous expenses without providing any opportunity of being heard to violating the principles of natural justice.

In doing so the Ld. AO also erred in not allowing the direction of the Hon’ble DRP, which had directed the AO to delete the adjustment; 7.

7.1 That on the facts and in the circumstances of the case, the Ld. AO has erred in charging interest under 234A, 234B, 234C and 234D of the Act, as consequences of the additions made in the assessment order passed under section 143(3) read with section 144C of the Act.

7.2 The Appellant denies its liability to such interest and prays that the AO be directed to delete the levy of aforesaid interest as it is entirely a result of additions/disallowance and consequential in nature.

I.T.A. 1906/D/2015 Assessment year: 2010-11

8.

8.1. The Ld. AO has erred in initiating penalty proceedings under Section 271(1)(c) read with Section 274 of the Act against the Appellant. The Appellant submits that the above grounds of appeal are mutually exclusive of and without prejudice to each another. Further, the Appellant craves leave to add, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal so as to enable the Hon’ble ITAT to decide on the grounds raised by the Appellant, as per law.”

Accordingly, for the purpose of economic analysis, the assessee combined the international transaction pertaining to payment of royalty as in this case; the transaction was so closely linked or continuous that it could not have been evaluated adequately on an individual basis. Therefore, the transactions pertaining to payment of royalty were considered as closely linked to the manufacture of glass door refrigerators and a combined transactions approach was used. The Ld. AR submitted that since the operating margin of the assessee was higher than the arithmetic mean of the operating margins of the comparable companies and the cost pertaining to the payment of royalty had already been benchmarked, the international transaction pertaining to the payment of royalty by FIPL to Frigoglass SAIC should be considered to be at arm’s length from the assessee’s perspective. The Ld. AR further submitted that Frigoglass SAIC had hired an independent external consultant for reviewing the arm’s length nature of 4% royalty applied by the Head Office for the licensing of the ICM technology and trademarks to related I.T.A. 1906/D/2015 Assessment year: 2010-11 group entities and based on the terms and conditions of the License Agreement between Frigoglass SAIC and its affiliates and in view of the broadly comparable licensing agreements identified from the search of publicly available license agreements, it was concluded that a royalty rate of 4% on sale of products for the use of trademarks and ICM technology was considered to be an arm’s length rate. It was also submitted that no independent third party will let any other entity use its Intellectual Property Rights (IPR) and allow to enjoy the benefits from the usage of such IPR without charging a fee. It was submitted that FIPL enjoys a lot of benefits in manufacturing and marketing from the use of the IPRs owned by Frigoglass SAIC. It was submitted that FIPL had started enjoying the benefits from the usage of the trademarks and ICM technology from very inception although a formal agreement was entered into in September 2007 and had started making payment for such services from Assessment Year 2009-10 only. It was further submitted that the activities performed by the AE in terms of the royalty agreement were ICM sales, customer service, marketing services, product development and future technologies. It was submitted that most of the clients of the FIPL were global clients and the use of the I.T.A. 1906/D/2015 Assessment year: 2010-11 trademark had a positive impact on the sales of FIPL in India.

The Ld. AR made a reference to the comparative profitability chart from FY 2005-06 to FY 2009-10 and submitted that the profitability has been increasing on an year to year basis because of availing of the services of Frigoglass SAIC and, therefore, since the benefits received from FIPL from receipt of such services outweigh the payment for such services, the assessee was justified in making payments for royalty.

I.T.A. 1906/D/2015 Assessment year: 2010-11 12. The Ld. AR submitted that in order to effectively track the time and cost utilized by each group entity, each group entity has an in house mechanism to capture all the direct and indirect cost incurred to provide these services to other group entities (including FIPL) and once the cost is accurately determined by each group entity, such cost details are sent to Frigoglass SAIC where similar costs are pooled from different Frigoglass entities globally. This combined cost pool is then adjusted for costs incurred on shareholder activities and duplicate services. Once a combined cost pool is determined, costs are allocated to different entities on the basis of benefits received by the particular entity.

The allocation keys used are compensation and benefit cost of the person providing the services and actual time spent by the person providing services allocated by using time sheets etc. At this stage, an appropriate mark-up is applied to the chargeable costs identified by Frigoglass SAIC and as per para 5 of the service agreement a mark-up of 6.5% is applied and billed to the respective Frigoglass group entity (including FIPL). The Ld. AR also submitted that Frigoglass SAIC had hired an independent external consultant for reviewing the Arm’s Length Nature of the 6.5% mark-up applied by the Head Office for rendering I.T.A. 1906/D/2015 Assessment year: 2010-11 management support services to related group entities. The search for comparable services providers resulted in the identification of 720 independent companies. These comparables exhibited an arm’s length inter-quartile range of 3.7% to 13.3% with a median of 7.4%. On the basis of this, the 6.5% cost plus mark-up charged by the Frigoglass group can be considered consistent with the arm’s length principle. The Ld. AR further submitted that the TPO has accepted the receipt of services as well as the needs and benefits availed by the assessee and has only challenged the computation mechanism for such services and that too disallowing only the mark-up charged on the cost allocated to AE, considering the same to be duplicative in nature and the DRP has simply followed the reasoning of the TPO without exercising an independent analysis. The Ld. AR refereed to the Allocation Sheet appearing on page 10 of the order of the TPO and submitted that the TPO has mixed up two sets of transactions viz. availing of services from AE at cost plus 6.5% mark-up and rendering services to AE at cost plus 15% mark-up.

Referring to Para (ii) on page 9 of the TPO’s order, the Ld. AR pointed out that the Agreement with Cyprus referred to in the said Para was an altogether different agreement, a copy of which I.T.A. 1906/D/2015 Assessment year: 2010-11 is placed at page 1470 of Paper Book IV. He submitted that in view of the apparent mistake on facts the matter should be set aside to the file of the TPO for verification as to whether the allocation of expenses has been correctly made as per the allocation sheets.

He placed reliance on the decision of the Hon'ble Delhi High Court in CIT vs Abhinandan Investment Ltd. in I.T.A. 1906/D/2015 Assessment year: 2010-11 130/2001 for the proposition that all colorable devices in the garb of tax planning should be ignored and substance over form should prevail. He also placed reliance on the decision of the Coordinate ‘I’ Bench of this Tribunal in Bombardier Transportation India Pvt. Ltd. vs DCIT in I.T.A. No. 1626/Del/2015 wherein the Bench had upheld the action of the DRP in determining the ALP of intra-group services received from its AE at nil. The Ld. DR submitted that the order of the DRP should be upheld.

“16. The Organization for Economic Cooperation and Development (“OECD‟, for short) has laid down transfer pricing guidelines” for Multi-National Enterprises and Tax Administrations. These guidelines give an introduction to the arm’s length price principle and explains article 9 of the OECD Model Tax Convention. This article provides that when conditions are made or imposed between two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises then any profit which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, if not so accrued, may be included in the profits of that enterprise and taxed accordingly. By seeking to adjust the profits in the above manner, the arm’s length principle of pricing follows the approach of treating the members of a multi-national enterprise group as operating as separate entities rather than as inseparable parts of a single unified business. After referring to article 9 of the model convention and stating the arm‟s length principle, the guidelines provide for I.T.A. 1906/D/2015 Assessment year: 2010-11 recognition of the actual transactions undertaken” in paragraphs 1.36 to 1.41. Paragraphs 1.36 to 1.38 are important and are relevant to our purpose. These paragraphs are reproduced below: -

“1.36 A tax administration’s examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as these are consistent with the methods described in Chapters II and III. In other than exceptional cases, the tax administration should not disregard the actual transactions or substitute other transactions for them. Restructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured.

1.37 However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises where the economic substance of a transaction differs from its form. In such a case the tax administration may disregard the parties’ characterization of the transaction and recharacterise it in accordance with its substance. An example of this circumstance would be an investment in an associated enterprise in the form of interest -bearing debt when, at arm’s length, having regard to the economic circumstances of the borrowing company, the investment would not be expected to be structured in this way. In this case it might be appropriate for a tax administration to characterize the investment in accordance with its economic substance with the result that the loan may be treated as a subscription of capital. The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, 21 I.T.A. 1906/D/2015 Assessment year: 2010-11 viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price. An example of this circumstance would be a sale under a long-term contract, for a lump sum payment, of unlimited entitlement to the intellectual property rights arising as a result of future research for the term of the contract (as previously indicated in paragraph 1.10). While in this case it may be proper to respect the transaction as a transfer of commercial property, it would nevertheless be appropriate for a tax administration to conform the terms of that transfer in their entirety (and not simply by reference to pricing) to those that might reasonably have been expected had the transfer of property been the subject of a transaction involving independent enterprises. Thus, in the case described above it might be appropriate for the tax administration, for example, to adjust the conditions of the agreement in a commercially rational manner as a continuing research agreement.

1.38 In both sets of circumstances described above, the character of the transaction may derive from the relationship between the parties rather than be determined by normal commercial conditions as may have been structured by the taxpayer to avoid or minimize tax. In such cases, the totality of its terms would be the result of a condition that would not have been made if the parties had been engaged in arm’s length dealings. Article 9 would thus allow an adjustment of conditions to reflect those which the parties would have attained had the transaction been structured in accordance with the economic and commercial reality of parties dealing at arm’s length.”

17. The significance of the aforesaid guidelines lies in the fact that they recognise that barring exceptional cases, the tax administration should not disregard the actual transaction or substitute other transactions for them and the examination of a controlled transaction should ordinarily be based on the transaction as it has 22 I.T.A. 1906/D/2015 Assessment year: 2010-11 been actually undertaken and structured by the associated enterprises. It is of further significance that the guidelines discourage re-structuring of legitimate business transactions. The reason for characterisation of such re-structuring as an arbitrary exercise, as given in the guidelines, is that it has the potential to create double taxation if the other tax administration does not share the same view as to how the transaction should be structured.

18. Two exceptions have been allowed to the aforesaid principle and they are (i) where the economic substance of a transaction differs from its form and (ii) where the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner.

19. There is no reason why the OECD guidelines should not be taken as a valid input in the present case in judging the action of the TPO. In fact, the CIT (Appeals) has referred to and applied them and his decision has been affirmed by the Tribunal. These guidelines, in a different form, have been recognized in the tax jurisprudence of our country earlier. It has been held by our courts that it is not for the revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur. We may refer to a few of these authorities to elucidate the point. In Eastern Investment Ltd. v. CIT , (1951) 20 ITR 1, it was held by the Supreme Court that “there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of the Income Tax Act”. It was further held in this case that “it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned”. In CIT v. Walchand & Co. etc., (1967) 65 ITR 381, it was held by the Supreme Court that in applying the test of 23 I.T.A. 1906/D/2015 Assessment year: 2010-11 commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. It was further observed that the rule that expenditure can only be justified if there is corresponding increase in the profits was erroneous. It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand, (1938) 6 ITR 636 that “expenditure in the course of the trade which is unremunerative is nonetheless a proper deduction if wholly and exclusively made for the purposes of trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense. The question whether an expenditure can be allowed as a deduction only if it has resulted in any income or profits came to be considered by the Supreme Court again in CIT v. Rajendra Prasad Moody , (1978) 115 ITR 519, and it was observed as under: -

“We fail to appreciate how expenditure which is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by way of expenditure must be debited irrespective of whether there is receipt of income or not. That is the plain requirement of proper accounting and the interpretation of Section 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income.” It is noteworthy that the above observations were made in the context of Section 57(iii) of the Act where the language is somewhat narrower than the language employed in Section 37(1) of the Act. This fact is recognised in the judgment itself. The fact that the language employed in Section 37(1) of the Act is broader than Section 57(iii) of the Act makes the position stronger.

22. Even Rule 10B (1)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was unremunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/ brand fee, because it has been suffering losses continuously. So long as the expenditure or payment has been 25 I.T.A. 1906/D/2015 Assessment year: 2010-11 demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. 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 a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised.

23. Apart from the legal position stated above, even on merits the disallowance of the entire brand fee/ royalty payment was not warranted. The assessee has furnished copious material and valid reasons as to why it was suffering losses continuously and these have been referred to by us earlier. Full justification supported by facts and figures have been given to demonstrate that the increase in the employees cost, finance charges, administrative expenses, depreciation cost and capacity increase have contributed to the continuous losses. The comparative position over a period of 5 years from 1998 to 2003 with relevant figures have been given before the CIT (Appeals) and they are referred to in a tabular form in his order in paragraph 5.5.1. In fact there are four tabular statements furnished by the assessee before the CIT (Appeals) in support of the reasons for the continuous losses. There is no material brought by the revenue either before the CIT (Appeals) or before the Tribunal or even before us to show that these are incorrect figures or that even on merits the reasons for the losses are not genuine.”

“33. The TPO has made the disallowance in question mainly on the basis of the benefit test. In this regard, it is seen that the payment of royalty cannot be examined divorced from the production and sales. Royalty is inextricably linked with these activities. In the absence of production and sale of products, there would be no question arising regarding payment of any royalty. Rule 10A (d) defines 'transaction’ as a number of closely linked transactions. Royalty, then, is a transaction 27 I.T.A. 1906/D/2015 Assessment year: 2010-11 closely linked with production and sales. It cannot be segregated from these activities of an enterprise, being embedded therein. That being so, royalty cannot be considered, and examined in isolation on a standalone basis. Royalty is to be calculated on a specified agreed basis, on determining the net sales which, in the present case, are required to be determined after excluding the amounts of standard bought out components, etc., since such net sales do not stand recorded by the assessee in its books of account. Therefore, it is our considered opinion that the assessee was correct in employing an overall TNMM for examining the royalty…..”

20. Hence, following the ratio of the Hon'ble Delhi High Court in CIT vs EKL Appliances (supra), we hold that the addition made

by the TPO and upheld by the DRP is unsustainable and is liable to be deleted. Hence, ground nos. 4.1 and 4.2 are allowed.

I.T.A. 1906/D/2015 Assessment year: 2010-11 21. Ground No. 4.3 on the issue of management fee is restored to the file of the TPO to verify as to whether the Head Office has correctly allocated the hours of service/cost of service rendered and also whether any other cost centres have been erroneously included in the allocation. The TPO is directed to examine the issue afresh after giving due opportunity to the assessee in this regard.

from para 10.2 of the DRP’s order that since the DRP has directed that the Assessing Officer had not noted any discrepancy or identified any expenditure which was either personal in nature or was not incurred for the purpose of business, the ad-hoc disallowance was not sustainable. In view of this specific direction of the DRP, we direct the TPO to pass the consequential order in this regard.

I.T.A. 1906/D/2015 Assessment year: 2010-11 Order pronounced in the Open Court on 08.04.2016.