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2025 (5) TMI 1638 - AT - Income TaxTP Adjustment - MAM selection - ALP of the intangible assets purchased by the Assessee should be calculated using the Net Present Value NPV/ Royalty Savings Method under Income Approach OR appropriate Comparable Uncontrolled Price (CUP) method used by the TPO - HELD THAT - Considering the facts of the assessee s case CIT(Appeals) has correctly observed that the CUP method adopted by TPO cannot be used without eliminating the differences between the transactions. TPO s CUP of US 15, 99, 998 which did not factor in margins earned during the option period was correctly not found to be reliable by Ld. CIT(Appeals). CIT(Appeals) correctly held that the 2002 prices cannot be applied to the transactions related to the impugned year under consideration. CIT(Appeals) correctly held that expected benefits from intangible property through Net Present Value calculation was an acceptable option to determine SLP of intangibles. In the absence of a comparable Ld. CIT(Appeals) has correctly applied the Royalty Savings Method used by the valuer under the income approach as an acceptable methodology for determining the ALP of intangibles. Further Ld. CIT(Appeals) held that the royalty rates adopted by the valuer (10% for technical know-how and 5% for trademarks) were not justified. Based on the OECD Transfer Pricing Guidelines Ld. CIT(Appeals) considered it more appropriate to apply a royalty rate of 3.5% for technical know-how and 3% for trademarks. CIT(Appeals) has adopted a well-reasoned approach while passing the order and we find no infirmity in the order of Ld. CIT(Appeals) so as to call for any interference. Downward adjustment being the difference of the ALP determined by the assessee and TPO added to the total income of the assessee - CIT(Appeals) noted that the TPO had made a downward adjustment to the ALP of intangibles but had not explained how this amount could also be considered as the assessee s income. AO and TPO did not refer to any provisions of the Income Tax Act that would support the addition of this amount as taxable income. Furthermore even if the assessee had transferred a cash asset to its associated enterprise the addition of this amount to the assessee s income was not justified. Therefore the Commissioner (Appeals) held correctly that the addition to the assessee s income was incorrect and deleted the same on the ground that double addition was not allowed under the Income Tax Act. Scaling down Upward adjustment made on sale of finished goods by holding that only ALP of Avecia products should be modified while that of non- Avecia should not be done - Commissioner (Appeals) upheld the Transfer Pricing Officer s findings that the assessee s submission of contracts alone could not substantiate the functions performed risks assumed and assets deployed by the associated enterprises (AEs) especially without the financial statements of Colour Ltd. The financial statements were crucial for verifying whether Colour Ltd. had actually performed the functions it claimed. The TPO also highlighted that Colour Ltd. did not provide technical know-how for non-Avecia products and that it did not assume any marketing or inventory risks which the assessee did not dispute. Commissioner agreed with the TPO that the FAR (Function Asset Risk) analysis provided by the assessee was insufficient and could not be accepted at face value. Regarding the choice of the most appropriate transfer pricing method CIT(Appeals) concurred with the TPO that TNMM could not be considered appropriate due to the faulty FAR analysis. Assessee s reliance on OECD guidelines which suggest that financial information may not be necessary if TNMM is the selected method was also found to be misplaced by Ld. CIT(Appeals). As the FAR analysis was deemed unreliable the method chosen by the assessee was held not to be appropriate. On the issue of the tested party the TPO s rejection of the assessee as the tested party was also upheld by Ld. CIT(Appeals) as both the assessee and Colour Ltd. owned valuable intangibles and the assessee failed to rebut the TPO s findings regarding their respective functions. The assessee s attempt to justify the use of the CUP (Comparable Uncontrolled Price) method was rejected by Ld. CIT(A) as the Transfer Pricing Report had already rejected CUP due to differences in product specifications risks functions and other factors. Ld. CIT(Appeals) agreed with the TPO s approach to determining the ALP of sales to AE which involved reducing a royalty markup from sales by Colour Ltd. as this was based on a functional/FAR analysis. CIT(Appeals) accepted the assessee s contention that the upward adjustment should apply only to the sales of Avecia products given that the 75.86% markup was on sales of these products. The assessee s arguments regarding the non-Avecia products were also considered but CIT(Appeals) ruled that the TPO s method was appropriate in this context. The final upward adjustment was determined to be Rs. 17, 76, 95, 458/- instead of the Rs. 32, 83, 64, 753/- initially proposed by the TPO. The addition to the assessee s income was confirmed to the extent of Rs. 17, 76, 95, 458/- providing some relief to the assessee. No infirmity in the order of Ld. CIT(Appeals) so at to call for any interference.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered by the Appellate Tribunal in this appeal filed by the Department against the order of the Commissioner of Income Tax (Appeals) for the assessment year 2007-08 are as follows:
2. ISSUE-WISE DETAILED ANALYSIS Issue 1: Determination of Arm's Length Price (ALP) of Intangible Assets Relevant legal framework and precedents: The determination of ALP in transfer pricing matters is governed by the provisions of the Income Tax Act and Income Tax Rules, including Rule 10B(4) which restricts the use of comparables older than two years from the relevant financial year. The OECD Transfer Pricing Guidelines provide accepted methodologies for valuation of intangibles, including the Comparable Uncontrolled Price (CUP) method and the Income Approach using Net Present Value (NPV) or Royalty Savings Method. Court's interpretation and reasoning: The TPO applied the CUP method relying on a 2002 transaction between the associated enterprise Colour Ltd. and Avecia Ltd., valuing the intangibles at Rs. 6.94 crore. The TPO rejected the assessee's valuation report prepared by an independent valuer using the Royalty Savings Method under the Income Approach, citing reliance on unaudited financial data and unbenchmarked royalty rates. The assessee challenged the CUP method on grounds that the 2002 transaction differed significantly from the 2007 acquisition in contractual obligations, economic conditions, and business scale, and that Rule 10B(4) prohibits use of comparables older than two years. The Commissioner (Appeals) agreed with the assessee that the CUP method was inappropriate due to fundamental differences between the transactions and the time gap. The Commissioner accepted the Royalty Savings Method as an acceptable alternative, subject to adjustment of royalty rates and benefit periods to reflect industry standards and facts. Specifically, the Commissioner reduced the royalty rate for technical know-how from 10% to 3.5%, and for trademarks from 5% to 3%, and extended the benefit period for know-how to 10 years. The goodwill valuation by the valuer was rejected due to lack of reliable data, and goodwill was valued nominally as per the Goodwill Purchase Agreement. Key evidence and findings: The valuation report by M/s. Dalal & Shah, though initially rejected by the TPO, was reconsidered with adjustments. The TPO's CUP relied on a 2002 transaction with significant contractual and economic differences. The assessee's submissions included sales data showing actual benefits realized exceeding initial valuation, and RBI approval for the acquisition price. The Commissioner found the TPO's CUP unreliable and the valuer's royalty rates excessive. Application of law to facts: The Tribunal upheld the Commissioner's approach, noting that Rule 10B(4) restricts use of comparables older than two years and that the 2002 transaction was not sufficiently comparable. The Tribunal accepted the Income Approach using NPV and Royalty Savings Method as appropriate in absence of reliable comparables. Adjusted royalty rates and benefit periods were found to be reasonable and in line with OECD Guidelines. Treatment of competing arguments: The Department's reliance on CUP was rejected due to non-comparability and outdated data. The assessee's use of hindsight was also rejected. The Commissioner's balanced approach of adjusting the valuer's methodology rather than outright rejecting it was endorsed. Conclusions: The ALP of intangibles was correctly determined at Rs. 17,88,08,043/- by the Commissioner (Appeals) using the adjusted Income Approach. The Tribunal found no infirmity in this determination and dismissed the Department's appeal on this ground. Issue 2: Addition of Downward Adjustment of Rs. 54,03,30,087/- to Assessee's Income Relevant legal framework and precedents: Transfer pricing adjustments must avoid double counting. The Income Tax Act does not permit simultaneous downward adjustment of asset value and upward addition of the same amount to income for the same transaction. Court's interpretation and reasoning: The TPO made a downward adjustment reducing the value of intangibles by Rs. 54,03,30,087/- and simultaneously proposed adding this amount as income on the basis that the assessee transferred a cash asset of similar value to the associated enterprise without consideration. The assessee contended this was double addition for the same transaction and legally impermissible. Key evidence and findings: The Commissioner (Appeals) noted the TPO and AO failed to cite any provision authorizing such addition. The downward adjustment to asset value and addition to income were contradictory and unsupported by law. The Commissioner deleted the addition on the ground of double addition not allowed under the Income Tax Act. Application of law to facts: The Tribunal agreed with the Commissioner (Appeals) that the addition of Rs. 54,03,30,087/- was not justified and constituted impermissible double counting. The adjustment should be either a reduction in asset value or an addition to income, not both. Treatment of competing arguments: The Department's argument for addition was rejected due to lack of legal basis and contradictory treatment of the same amount. Conclusions: The Tribunal upheld the deletion of the addition and dismissed the Department's appeal on this ground. Issue 3: Scaling Down of Upward Adjustment on Sale of Finished Goods Relevant legal framework and precedents: Transfer pricing methods must be chosen based on reliable FAR (Functions, Assets, Risks) analysis. The Transactional Net Margin Method (TNMM) and Profit Split Method (PSM) are recognized methods, but application depends on availability of data and functional analysis. The use of royalty mark-ups must be justified by the ownership and use of intangibles. Court's interpretation and reasoning: The assessee applied TNMM using eight comparables and claimed an operating margin of 15.89%, significantly higher than comparables' average of 4.88%. The TPO rejected TNMM due to lack of financial data of the associated enterprise (Colour Ltd.), which prevented verification of FAR. The TPO found Colour Ltd. to be a mere routing entity with limited functions and risks, and thus rejected TNMM and proposed a 15% royalty mark-up on sales to Colour Ltd., resulting in an upward adjustment of Rs. 32,83,64,753/-. The assessee argued that the royalty mark-up should apply only to Avecia products, not non-Avecia products. The Commissioner (Appeals) concurred with the TPO's rejection of TNMM due to unreliable FAR analysis and absence of Colour Ltd.'s financials. The Commissioner agreed that Colour Ltd. did not bear significant risks or functions beyond providing technical know-how for Avecia products. However, the Commissioner reduced the royalty rate to 6.5% and limited the upward adjustment to sales of Avecia products, scaling down the adjustment to Rs. 17,76,95,458/-. Key evidence and findings: The TPO's findings on Colour Ltd.'s limited role and lack of financial data were critical. The assessee's breakdown of sales and argument for excluding non-Avecia products was accepted in part. The Commissioner's adjustment reflected a balanced approach. Application of law to facts: The Tribunal upheld the Commissioner's approach, noting that the absence of complete financial data justified rejection of TNMM and that the royalty mark-up method with adjusted rate and product limitation was appropriate. The FAR analysis supported the limited role of Colour Ltd. and the need to exclude non-Avecia products from adjustment. Treatment of competing arguments: The Department's challenge to scaling down was rejected. The assessee's arguments on FAR and product differentiation were partially accepted. Conclusions: The Tribunal found no infirmity in the Commissioner's order reducing the upward adjustment and limiting it to Avecia products. The Department's appeal was dismissed on this ground. 3. SIGNIFICANT HOLDINGS "The CUP method adopted by TPO cannot be used without eliminating the differences between the transactions. The TPO's CUP of US $ 15,99,998, which did not factor in margins earned during the option period, was correctly, not found to be reliable by Ld. CIT(Appeals). Further, Ld. CIT(Appeals) correctly held that the 2002 prices cannot be applied to the transactions related to the impugned year under consideration." "In the absence of a comparable, Ld. CIT(Appeals) has correctly applied the Royalty Savings Method, used by the valuer under the income approach, as an acceptable methodology for determining the ALP of intangibles." "The royalty rates adopted by the valuer (10% for technical know-how and 5% for trademarks) were not justified. Based on the OECD Transfer Pricing Guidelines, Ld. CIT(Appeals) considered it more appropriate to apply a royalty rate of 3.5% for technical know-how and 3% for trademarks." "Double addition was not allowed under the Income Tax Act. The addition of Rs. 54,03,30,087/- to the assessee's income was incorrect and rightly deleted by Ld. CIT(Appeals)." "The FAR analysis provided by the assessee was insufficient and could not be accepted at face value. The TPO's rejection of TNMM and the adoption of a royalty mark-up method with a reduced rate of 6.5% limited to Avecia products was appropriate." "The Commissioner (Appeals) adopted a well-reasoned approach in scaling down the upward adjustment from Rs. 32,83,64,753/- to Rs. 17,76,95,458/-. There is no infirmity warranting interference." Final determinations:
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