TMI Blog2011 (5) TMI 365X X X X Extracts X X X X X X X X Extracts X X X X ..... vailable in respect of uncontrolled transactions which are similar or at least closely similar to the transactions of the assessee company with its associated enterprise Cabot Corporation, USA - Appeal is allowed by way of remand to AO Regarding royalty - Revenue or capital expenditure - It may also be pertinent to note here that a similar payment of royalty under the same technology agreement was made by the assessee right from the year 1990 and the deduction claimed for the same as revenue expenditure was allowed consistently by the Department in the earlier years - It was held that the intention of the assessee was to acquire technical knowledge or know-how for certain period and the drawings acquired were part of technical knowledge. It was held that the assessee thus did not acquire any asset or benefit of enduring nature and the payments made under the agreement were allowable as revenue expenditure - Appeal is partly allowed - P.M. JAGTAP, N.V. VASUDEVAN, JJ. M.M. Golavala for the Appellant. Smt. Malathi R. Sridharan for the Respondent. ORDER P.M. Jagtap, Accountant Member. These two appeals, one filed by the assessee being ITA No. 6622/Mum/2009 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a total royalty payment of Rs. 5,62,67,860 was made by the assessee to Cabot Corporation in the year under consideration, the details of which are as under : Grade Amounts (Rs.) Carcass (5 per cent) 2,66,19,453 Trade (3 per cent) 2,25,15,217 4,91,34,670 Add : R D cess 24,56,733 5,15,91,403 Add : Short provision For preceding year 46,76,457 Total 5,62,67,860 5. In its transfer pricing study/analysis, the payment of royalty made to Cabot Corporation, USA as above was claimed to be at arm's length by the assessee company on the basis of Comparable Uncontrolled Price (CUP) method adopted by it. When this matter relating to computation of arm's length price in relation to the international transactions was referred by the Assessing Officer to the TPO under section 92CA(1), the TPO noted from the supplementary agreement dated 3-7-2004 that no reasons were specifically assigned for the enhanced royalty rate of 5 per cent agreed to be paid by the assessee to Cabo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d in the manufacturing of the product as a result of the technological support received from AE. In this regard, it may be pointed out that all these strides recorded by the assessee very much formed the part of the technological agreement already entered by the assessee with the AE in the year 1990. There is nothing in the supplementary agreement, which is enabling the assessee to record better performance. The supplementary agreement is only enhancing the rate of royalty payable to the AE. The technology that is being transferred is on continuous basis and is governed by the clauses of the technological collaboration agreement initially entered in the year 1990 which got renewed in the year 1998. (c) The assessee has also taken the argument that the parent, namely Cabot Corporation, USA is engaged in significant R D activity for its plant located in Massachusetts and Texas. The advances in product and process developments are passed on to the subsidiaries. It is also contended by the assessee that for the financial year ending September 2004 Cabot Corporation had spent USD 53 Millions, which got increased to USD 59 Millions for the year ending September 2005. According to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0.19 NP/Sales % 6 0.60 (07.32) OP/Sales % 8 1.15 (11.68) OP/TC % 9 1.16 (10.38) As is evident from the above, during the last 3 years the turnover of the assessee has hardly changed (On the contrary, it has declined from Rs. 148.7 crores in assessment year 2003-04 to Rs. 146.77 crores in assessment year 2005-06). The total costs of the assessee have increased from Rs. 137 crores in the assessment year 2003-04 to Rs. 164 crores in the assessment year 2005-06. The operating profits of the assessee have gone down sharply during this period. In fact, during the year in question, the assessee is making operating losses. The business may make profits or losses as a result of acquisition of technology, but when a contention is taken with regard to the better performance and productivity achieved by the assessee as a result acquisition of such technology, then the contention taken cannot stand in total disregard to the performance on record. The contradiction between the contention taken by the assessee with regard to the higher productivity and the performance achieved ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (iii) The data itself is insufficient and fails to provide any basis to the price setting mechanism whereby the requirement of the business mandated payment of royalty at a higher rate for the technology/know-how sought to be received by the assessee by entering into a supplementary agreement to that effect. In view of this, the argument of the assessee is rejected. (g) The assessee has further submitted that in the post liberalization era in the country, the barriers of the industry insulations are getting broken. The assessee has submitted that if the same technologies were to be acquired from an outsider it would have charged not less than 10 per cent of the fees. The argument of the assessee is hypothetical in nature. It defies the basic principle of transfer pricing. Transfer Pricing is all about considering the Controller Transactions of an assessee with its AEs with the uncontrolled transactions, of independent parties. There is nothing hypothetical about it. If, sufficient data regarding the Uncontrolled Transaction is not obtainable or is not reliable enough, then a different method as provided in the Act has to be considered to determine the arm's length nature of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... per cent of sales. (b) On carcass grade carbon black or 5 per cent of sales. 7.5 In the preceding year on carcass grade carbon black the royalty was paid at 2 per cent but this year since the same was enhanced to 5 per cent it lead to disallowance of 3 per cent. It is relevant to add that royalty paid on other interconnected trade grade carbon black at 3 per cent has been accepted as a CUP by the TPO's being at arms length price. 7.6 It is a fact that the appellant has extensively documented and substantiated the benefits denied by the appellant in lieu of Royalty payment. This documentation justifies the payment of royalty but the rate (2 per cent or 5 per cent) is subject-matter of dispute. It is seen from the commentary filed by the appellant during the appellate proceedings that there is no technological differences between trade grade carbon black on which 3 per cent royalty has been paid and the carcass grade carbon black where it has jumped to 5 per cent this year. The only difference is of minor nature and that relates to pellet size. Therefore once the rate of 3 per cent is accepted as CUP for the trade grade the same rate necessary must apply to carcass grade. Mor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing whether the royalty so paid is at arm's length has to be done independently as per the procedure laid down in the relevant provisions of the Act as well as the rules prescribed. In this regard, it is observed that royalty paid at the rate of 5 per cent was claimed to be an arm's length price by the assessee on the basis of CUP method. The Assessing Officer, on the other hand, has not referred to any method specifically and made the addition on account of transfer pricing adjustment taking the rate of 2 per cent at which royalty was paid by the assessee in the earlier years as a benchmark. As already observed by us, the said royalty at the rate of 2 per cent was paid by the assessee company to its associate enterprise and the same, therefore, could not be taken as a comparable uncontrolled price. 9. At the time of hearing before us, the learned representatives of both the sides have accepted in reply to a query raised by the Bench that the product manufactured by the assessee being unique and the technology or technical input provided by Cabot Corporation, USA also being unique one, it is very difficult to find out a case involving supply of similar technology or technical inp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of the method; (d) the degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions; (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction, and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to be made in application of a method." 11. In our opinion, if the facts of the present case are considered in the light of the above factors, CUP method cannot be regarded as most appropriate method for determining arm's length price of the royalty paid by the assessee to M/s Cabot Corporation, USA as there is no data available in respect of uncontrolled transactions which are similar or at least closely similar to the transactions of the assessee company with its associated enterprise Cabot Corporation, USA. We, therefore, set aside the order of the learned CIT(Appeals) as well as that of the Assessing Officer on this issue and restore the matter to the file of the Assessi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lty was a revenue expenditure which, as summarized by the learned CIT(Appeals) in his impugned order is reproduced hereunder : "(a) The appellant has been in the business of manufacturing carbon black for more than 40 years. (b) The foreign company was required under the terms of the agreement to render technical advice and assistance in connection with manufacture in the same field, where the company was already manufacturing and doing business. (c) By incurring the said expenditure, the appellant did not enter into a new business or a new field or acquire any asset. (d) In the context of the current competitive business environment, such an expenditure is nothing but a day-to-day expenditure intended to improve the efficiency and profitability of the existing business. (e) The Assessing Officer accepts that the expenditure has been incurred to improve the profitability of the Company- his subsequent inference that the expenditure is capital is wholly erroneous. (f) The Appellant has not acquired any know-how by way of an asset. It is only entitled to the use of know-how to assist in its manufacturing process. (g) The reference by the Assessing Officer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gns and technical data comprising the Technology package shall have been used in commercial operation and proven in at least four (4) plans of Cabot. The Technology Package will be in such a form that a competent local engineering firm should be able to complete the detailed design. 4.6 Thereafter, Article IV provides for certain technical services and, in particular, training of the appellant employees. 4.7 Under Article XI, the assessee is required to maintain strick confidentiality and is not permitted to part with information to any third party. 4.8 Under Article XII, there is no right of assignability or sub-licensing unless the parent company gives written consent and agrees on the terms and conditions such sub-licensing." 17. After analyzing the above features of the agreement, the following facts were found to have emerged by the learned CIT(Appeals) which, according to him, were material for consideration : (i) The appellant is a single factory, single product company manufacturing carbon black since 1963. (ii) It has ISO certification and has to constantly endeavour to maintain high technical standards for its own survival and to keep itselfs, competitive ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isconceived. In the judgment of the Madras High Court 148 ITR 272 only 25 per cent of the royalty had been disallowed and 75 per cent had been duly allowed as revenue expenditure. Even so, the said decision needs to be confined to its own peculiar facts, as the head notes of both the judgments state that there were clauses in the Collaboration Agreement contemplating setting up of a factory. It is under these peculiar facts that 25 per cent of the royalty expenditure was treated as capital. In the instant case, the factory of the appellant was set-up in 1963, and the expenditure incurred in the current year can under no circumstance be equated with the setting up of a factory. The appellant has been engaged in the same field of manufacture for more than 40 years." 19. The learned CIT(Appeals) also noted that payment of royalty made by the assessee to M/s Cabot Corporation, USA right from year 1990 was claimed and allowed as a revenue expenditure. He further noted that this issue was a subject-matter of proceedings under section 263 for assessment year 2003-04 and the learned CIT after examining all the relevant aspects did not consider it fit to withdraw the deduction allowed by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quired any asset or advantage of enduring nature and the expenditure on payment of royalty was incurred merely to improve its efficiency and profitability. 21. In the case of Alembic Chemical Works Co. Ltd. (supra), Hon'ble Supreme Court has held that the improvisation in the process and technology in some areas of the enterprise was supplemental to the existing business and there being no material to hold that it accounted to a new or fresh venture, the payment made was on account of revenue expenditure. Hon'ble Supreme Court further held that the relevant agreement pertained to a product already in the line of the assessee's established business and not to a new product. What was stipulated in the agreement was in respect of improvement in the operations of existing business and its profitability not removed from the area of the day to day business of the assessee's established enterprise. It was held that the financial outlet under the agreement was for the better conduct and improvement of the existing business and it was thus expenditure of revenue nature. In the case of Kirloskar Pneumatic Co. Ltd. (supra), the assessee was manufacturing air compressor. It entered into an a ..... 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