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Income Tax Appellate Tribunal, MUMBAI ‘K’ BENCH, MUMBAI
Appearances by: Karishma R. Phatarphekar, Divyesh I. Shah, Harsh Shah, Pratik Poddar, for the assessee N.K. Chand, for the Assessing Officer Date of concluding the hearing : January 14th, 2016 Date of pronouncing the order : March 31st, 2016 O R D E R Per Pramod Kumar, AM:
These cross appeals, and the cross objection, are directed against the order dated 5th November, 2012, passed by the leaned CIT(A), in the matter of assessment under section 143(3) of the Income Tax Act, 1961 (‘the Act’ hereinafter) for the assessment year 2007-08.
In , i.e. Assessing Officer’s appeal, against learned CIT(A)’s order dated 05.11.2012, the only grievance is as follows:-
“On the facts and circumstances of the case and in law, the Ld. CIT(A) erred in deleting the addition relating to payment of royalty u/s.92CA(3) of the I.T. Act amounting to Rs.3,80,99,599/- regarding the Arm’s Length Price arrived by the TPO of International Transaction.” 3. In a connected cross objection, filed by the assessee against the same order, the assesse has raised the following grievance:-
“On the facts and in the circumstances of the case and in law, the learned Transfer Pricing Officer and the Hon’ble Commissioner of Income Tax (Appeals) erred in rejecting the appellant’s contention that as the payments of Royalty were approved by the Reserve Bank of India the same was at arm’s length.” 4. The relevant material facts are as follows. The assesse before us is a subsidiary of Schenectady (India) Holdings Pvt. Ltd. which, in turn, is a wholly owned subsidiary of & 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 3 of 11 SI Group Inc. USA. The assessee is engaged in the manufacture and sale of organic chemicals and phenolic resins having wide range of industrial applications. During the course of proceedings before the Transfer Pricing Officer, it was, inter alia, noted that the assessee has made a payment of Rs.3,39,67,540/- towards royalties. However, the Transfer Pricing Officer held arm’s length price of the royalty at NIL on the basis of following reasoning:-
“3. Payment of Royalty In the form 3CEB, the assessee has reported payment of Royalty of Rs.3,39,67,540 /- to SI Group Inc. In the form 3CEB, a note was appended that RBI approval has been obtained for payment of royalty and hence it is at ALP. The assessee was asked to give the economic justification & evidence that it is at ALP. The assessee vide letter dated 10 March 2010 had given a detailed reply. It was submitted that the royalty was paid under the License & Technical Assistance Agreement with SI Group Inc for - exclusive license for production & sale - supply of all know-how related to new technology - Technology update for production of various products. It was further submitted that the know-how was provided by the AE in relation to production of goods & 2% of net sales price was paid as royalty. It was also stated that there was consistent increase in sales which would not have been possible but for the payment of technical fee. The assessee had also given details of royalty paid by other SI Group entities which was in the range of 2% to 3%. It was further contended that as the AE is located in a high tax jurisdiction there is no incentive to shift profits to overseas jurisdiction. It was seen that the License & Technical Assistance Agreement was entered on 15 May 2004 between the assessee and SI Group Inc. The RBI approval provides that, "our approval is only towards technology transfer from FEMA angle and should not be construed as approval under the provisions of any other law in force". Hence, the contention that the RBI approval would show that the payment was at ALP is without merits. The assessee has not demonstrated with any evidence as to the specific benefits obtained under the agreement which would justify the payment of royalty. The perusal of the assessee's financial statements shows that the assessee has not derived any incremental benefit on account of payment of royalty. The important information is tabulated as follows;- (Amount in Crores) Particulars 31-3-05 (15 31-3-06 31-3-07 month)
& 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 4 of 11 Net Sales 709.60 516.81 607.34 Profit Before Tax 31.70 6.85 -2.43 Basic Chemicals (Sales) 470.96 300.96 382.72 Industrial Solvents (Sales) 188.30 147.07 131.21 Performance Resins (Sales) 11.13 17.22 27.36 Further as per the annual report of the assessee there was no mention of new technology utilized under the agreement which enhanced the sales or production. On the other hand, the annual reports for 2005-06 &. 2006 -07 clearly state: "The technology acquired by the Company in the past for production of cumene, phenol, acetone, phenolic resins have been fully absorbed. The technologies have been further upgraded over the years through in house innovation and knowledge engineering"
Thus, it can be inferred that there was no technology utilized under the said agreement to justify royalty payment. Even otherwise the assessee failed to benchmark that the payment was at ALP. That other AEs have paid at similar rates would not benchmark the transaction, as all were controlled transactions. In view of this an adjustment of Rs.3,39,67,540/- is to be made as assessee failed to give economic justification for the payment of royalty.”
Aggrieved, assessee carried the matter in appeal before the leaned CIT(A) who deleted the said adjustment by observing, inter alia, as follows:
“6.5 I have considered the facts of the case, submission of the appellant as against the findings/observations of the AO/TPO in their order u/s. 143(3) r.w.s. 144C/92CA (3) of the I.T. Act. The contentions and submissions of the appellant are being discussed and decided here in under: i. The appellant has made payment of royalty @ 2% of the net sales pursuant to the licences and technical assistance agreement entered into by the appellant on 15.05.2004 with S.I. Group Inc. This agreement has an approval from the RBI. ii. The TPO has observed that the appellant has not demonstrated with any evidence, the specific benefits obtained under the agreement which would justify the payment of royalty. The TPO has further, tabulated the net sales, profit before the tax and sales of individual group of chemicals for the period ending 31.03.2005 (15 months), 31.03.2006 and 31.03.2007 and has observed that the assessee has not derived any incremental benefits on account of payment of royalty. The TPO has further, reproduced a portion of the annual report of the assessee and has accordingly inferred that there & 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 5 of 11 was no technology utilised under the said agreement justifying royalty payment. The TPO has further, mentioned that the payment of royalty by other AEs could not bench mark the transaction as all were controlled transaction. Accordingly, observing that the assessee has failed to give economic justification towards the payment of the royalty an adjustment of the amount of the payment of royalty to the tune of Rs.3,39,67,540/- was made by the TPO. iii. The appellant in its submission has given details in respect of commercial rights that the appellant has obtained by virtue of the agreement. The appellant has further submitted the details in respect of receipt of latest technology and technical assistance from AE on continuous basis under the sub-headings as under :- - Technical support for continuously customizing Standard Operating Procedures. - Technical support for assistance in production process and trouble shooting. - Cost saving projects - Access to Internal Portal for online technical support services. - Technical Audits conducted by the AE - Plant /site visit by Indian employees at overseas locations. - Plant/site visit by employees of the AE in India. - Introduction of new raw-material purification system, The details in this regard, have been summarised in sub-para 6.4 above. Under such circumstances, it cannot be said that the appellant has not been able to demonstrate the receipt of technology and technical support on continuous basis. iv. The TPO in his order has also not brought any fact to the contrary to such submission of the appellant. v. The appellant has contended regarding the observations of the TPO that approval of RBI cannot be considered for determination of arm's length price. The appellant has relied on Rule 10B(2)(d) and on the various decisions in this regard. In respect of such contentions of the appellant, it is mentioned that the approval of the RBI for the payment of royalty is from the perspective of foreign exchange management Act. Under such circumstances, though the bona fide of the payment to be made or made by the appellant cannot be doubted but it remains to be examined whether such payments made by the appellant is inconformity with an arm's length principle as per the Indian Transfer Pricing Regulations. The Hon'ble Punjab & Haryana High Court in the case of Coca Cola India Inc. Vs. ACIT (P & H) (2008-TIOL-658-HC-P & H -IT) have clearly observed that the approval of RBI would not be determinative factor from the perspective of transfer pricing regulations. Accordingly, such contention of the appellant & 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 6 of 11 that the approval of the RBI should be considered as determination of arm's length price is not found to be acceptable. vi. The appellant in its submission has given details in respect of benefits obtained by the appellant from availing technical assistance from AEs, has indicated that there has been increase in the turnover by 25% and there has been increment in the production. The appellant has further made its submission that the loss or reduction in profit is on account of higher interest cost and higher depreciation and not because of the payment of royalty. In this regard, it is stated that the payment of royalty is for the benefit which should be translated in the economic term, over a period of time. vii. The appellant has contended that the royalty payment has been made for the purposes of business and relied on various decisions in this regard. It is mentioned that the payment of royalty may have been made by the appellant for the business purposes. But what is important from the transfer pricing perspective is the determination of arm's length price of such payment of royalty by the appellant. viii. The appellant in its submission has contended that the TPO has not applied any method for benchmarking the royalty payment and simply disallowed the same. In this regard, it is stated that the TPO having dissatisfied with the fact that appellant has not demonstrated the economic justification for the payment of royalty, has come to the conclusion that payment of royalty in the instant case was not required. Accordingly, he proceeded to disallow the royalty payment. Such disallowance made by the TPO without bringing on record the contrary facts to what has been stated and submitted by the appellant is not found to be acceptable. ix. The appellant had also submitted the list of Group entities paying royalty between 2 to 3%. The same has been rejected by the TPO being controlled transactions. In this regard, it is mentioned that such observation of the TPO that the transactions are controlled in nature is valid but at the same time such details do indicate that the other entities of the S.I. Group are paying royalty on net sale price ranging from 2 to 3%. In that perspective royalty paid @2% of the net sales by the appellant is in order and is conforming intra-group transfer pricing policy. x. The TPO in his order has also observed that appellant has not benchmarked this transaction. During the course of appellate proceedings, the benchmarking analysis conducted by the appellant was submitted additional evidence under rule 46A. It has been contended by the appellant that it case falls under clause (d) of Rule 46A of the I.T. Rule, 1962. Such additional evidence submitted by the appellant was forwarded to the TPO who after examining the same, has submitted his report vide his letter No. Addl. CIT/TP-II(4)/ Addl. Evidence/12-13 dated 26.9.2012. The contents of the report of the TPO has been reproduced as sub-para 6.3 above. It is seen & 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 7 of 11 from the report of the TPO that he has not specifically disputed the benchmarking analysis conducted by the appellant and has mentioned that the calculation of arm's length price rate of royalty payments answers only secondary reasons for the disallowance of royalty by the TPO, the primary ground being the economic justification which has not been answered xi. This being the fact that the appellant has not benchmarked this international transaction and further, before passing the order by the TPO, the appellant has not given any specific opportunity to benchmark this international transaction. Such benchmarking analysis submitted by the appellant by way of additional evidence is considered to be admissible and is admitted for the purpose of consideration and decision of this ground of appeal. xii. It is seen that the appellant has made payment of royalty @2% of the net sales whereas the arithmetic mean of royalty rate as a percentage of turnover of broadly comparable companies has been determined @ 4.31%. This demonstrates the rate of royalty paid by the appellant being lower compared to the arithmetic mean of the payment of royalty by the broadly comparable companies. Under such circumstances, the rate of royalty @2% of the net sales will have to be considered to be confirming the to the arm's length standard as per the Indian Transfer Pricing Regulations. xiii. As far as TPO's contention regarding economic justification for payment of royalty is concerned, it is mentioned that the appellant has given elaborate details with enclosures evidencing nature and receipt of technology and technical support. Further the TPO has not brought any fact to the contrary in his order. Accordingly, the contention/observation of the TPO that appellant not been able to give economic justification is not found to be acceptable. xiv. It is seen from the order of the TPO that he has overwhelming relied on the mention in the annual report in respect of technology absorption by the company. Such mention in the annual report cannot be determinative of the fact that there was no continuous technological support and assistance received by the appellant company. xv. In view of the facts of the case and discussion herein above, the disallowance made by the TPO by arriving at the arm's length price of international transaction relating to the payment of royalty by the appellant at nil is not found to be justified. Accordingly, such adjustment made by the TPO is directed to be deleted. Accordingly, Ground no.3 is allowed.” 6. The Assessing Officer is aggrieved by the relief so granted by the learned CIT(A) and is in appeal before us.
& 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 8 of 11 7. We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.
We find that the issue is covered, by our order of even date in assessee’s own case for the assessment year 2006-07, wherein we have held as follows :-
“7. We have heard the rival submissions, perused the material on record and duly considered facts of the case in the light of the applicable legal position. We find that the Transfer Pricing Officer did note, and was apparently swayed by the fact of assessee’s making losses. It was for this reason that the payment of royalty was held to be not at an arm’s length price, as is implicit in the Transfer Pricing Officer’s observation to the effect that “having considered the submission made by the assessee in respect of payment of royalty, the position of the assessee cannot be accepted due to the fact that the assessee has incurred an operating loss during the year under consideration”. The Transfer Pricing Officer has thereafter proceeded to treat the arm’s length price of the royalty as “NIL”, thus virtually disallowing entire royalty payment. It is not, however, clear as to under which method of ascertaining the arm’s length price, the value of royalty has been determined as “NIL”. There cannot be an adhoc adjustment in the course of ascertaining the arm’s length price. If the Transfer Pricing Officer was to reject the assessee’s benchmarking on the basis of Reserve Bank of India’s approval under CUP method, the Transfer Pricing Officer was required to decide the correct mechanism of deciding the arm’s length price and compute the arm’s length price on that basis. It was not open to him to simply brush aside the benchmarking done by the assessee and adopt the NIL value. That is not a scientific method of determining the arm’s length price and it cannot meet any judicial approval. In this view of the matter, and also having regard to a series of judicial precedents from the co-ordinate benches holding that even Reserve Bank of India’s approval of royalty can be a reasonable CUP input for determining arm’s length price – such as in the case of DCIT vs. Owens Corning Industries (India) Pvt. Ltd., and vice versa (ITA Nos.549 & 595/Hyd/2014). We consider it appropriate to uphold the grievance of the assessee, and delete the impugned adjustment of Rs.2,71,11,495/-. The assessee gets the relief accordingly.”
As regards Hon’ble Punjab & Haryana High Court’s judgment in the case of Coca Cola India Inc. vs. ACIT [(2009) 221 CTR 225 (P&H)] relied upon by the learned CIT(A) holding that RBI approval will not be determinative factor, we may only point out that this view has not found favour with Hon’ble Supreme Court in the sense that Hon’ble & 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 9 of 11 Supreme Court has, in the case of Coca Cola Inc. vs. ACIT [(2011) 336 ITR 1 (SC)] set aside this order, and directed the authorities to “decide the matter uninfluenced by any of the observations made in the impugned judgement”.
In any event, learned Departmental Representative has not been able to controvert very well-reasoned findings of the learned CIT(A). In view of these discussions, as also bearing in mind entirety of the case, we approve the conclusions arrived at by the learned CIT(A) and decline to interfere in the matter. As for the issue raised in the Cross Objection, though academic, it has been held to be in favour of the assessee for the assessment year 2006-07 and we see no reasons to take any other view of the matter now as well. Leaned CIT(A)’s conclusions are approved for this reason as well.
In the result, the appeal filed by the Assessing officer is dismissed and the Cross Objection filed by the assessee is allowed.
We now take up the appeal filed by the assessee.
Ground no.1 is general in nature and does not call for any adjudication.
In ground nos.2, 3 and 4, which we will take up together, the assessee has raised the following grievances:-
Ground No.2 – Addition under Section 92CA(3) of the Act in respect of import of product 2, 4 DTBP from the associated enterprise, amounting to Rs.16,34,685. 2.1 On the facts and in the circumstances of the case and in law, the Learned CIT(A) has erred in confirming the addition made by AO/TPO relating to import of the product 2, 4 DTBP, to the extent of Rs.16,34,685 under Section 92CA(3) of the Act by not appreciating the submissions made by the Appellant.
& 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007-08 Page 10 of 11 2.2 The Appellant prays that the Transfer Pricing adjustment made under Section 92CA(3) of the Act in relation to import of product 2, 4 DTBP is erroneous, unwarranted and be deleted.” Ground No. 3 - Addition under Section 92CA(3) of the Act in respect of export of the product DPO to the associated enterprise, amounting to Rs. 7,99,076. 3.1 On the facts and in the circumstances of the case and in law, the Learned CIT(A) has erred in confirming the addition made by AO/TPO relating to the export of the product DPO, amounting to Rs. 7,99,076 to its AE, under Section 92CA(3) of the Act by not appreciating / disregarding the benchmarking analysis, comparable transactions selected and the detailed submissions and the documentary evidence supplied by the Appellant. 3.2 The Appellant prays that the Transfer Pricing adjustment made under Section 92CA(3) of the Act in relation to export of the product DPO is erroneous, unwarranted and be deleted. Ground No. 4 - Addition under Section 92CA(3) of the Act in respect of export of the product PTBP to the associated enterprise, amounting to Rs. 16,98,298. 4.1 On the facts and in the circumstances of the case and in law, the Learned CIT(A) has erred in confirming the addition made by AO/TPO relating to the export of the product PTBP, amounting to Rs. 16,98,298 to its AE, under Section 92CA(3) of the Act by not appreciating/disregarding the benchmarking analysis, comparable transactions selected and the detailed submissions and the documentary evidence supplied by the Appellant. 4.2 The Appellant prays that the Transfer Pricing adjustment made under Section 92CA(3) of the Act in relation to export of the product PTBP is erroneous, unwarranted and be deleted.
We will take up all these grounds of appeal together.
So far as the above three grounds of appeal
s are concerned, the common thread in all these three grounds are that the related adjustments are made by the Transfer Pricing Officer without giving any detailed reasons in his order. He has merely stated the fact of the impugned adjustment and left at that. When assessee raised the grievance before the DRP, the DRP observed that the TNMM was rejected as the TPO was able to find internal CUP but does not give any further details. It is difficult to even & 1009/Mum/2013 & C.O. No.192/Mum/2013 Assessment year: 2007
08. Page 11 of 11 understand, much less examine, the reasoning adopted by the authorities below in making these three adjustments. The assessee, aggrieved inter alia by these ALP adjustments is in appeal before us.
We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.
In our considered view, and particularly as the orders of the authorities below donot set out the material facts and analysis in sufficient detail, this matter is required to be remitted back to the assessment stage with a direction to the TPO to adjudicate upon these issues de novo, by way of a speaking order and after giving yet another reasonable opportunity of hearing. The assessee is at liberty to take such plea, as may be advised, and the TPO shall adjudicate upon the pleas so taken by way of a speaking order. With these directions, the matter stands restored to the assessment stage.
Ground no. 2, 3 and 4 are thus allowed for statistical purposes.
The appeal filed by the assessee is thus partly allowed for statistical purposes in the terms indicated above. Pronounced in the open court today on the 31st day of March, 2016.