TMI Blog2011 (5) TMI 566X X X X Extracts X X X X X X X X Extracts X X X X ..... muneration at much higher rate It is held that expenditure was neither excessive nor unreasonable, the same could not be disallowed under Section 40 A (2) of the Act - assessee has been able to discharge its burden namely it was a justifiable and reasonable business expenditure and thus should be allowed under Section 37 of the Act - Tribunal has held that the assessee having discharged the initial onus, burden shifted to the Revenue to show that the payment of royalty was excessive or unreasonable having regard to the legitimate needs of business or that the assessee has made less than ordinary profits and the Revenue has not discharged the said onus - Revenue has not specified as to how much ordinary profit was supposed to be and basis of its determination, before treating royalty payment as excessive and unreasonable. Coming to Section 92 of the Act, the CBDT has itself clarified in its Circular No. 14 dated 27.11.2001 that Section 92 of the Act does not apply in respect of payment of royalty etc which are not the part of regular business carried on between a resident and a non- resident. This aspect is suitably dealt with by the Tribunal and we agree with its rea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o Sections 40A (2) (b) and Section 92 of the Act and held that he was entitled to go into the question of reasonableness of the said payments and find out whether the said expenditures were wholly and exclusively for the purpose of carrying out business. He also referred to Article 9 of the DTAA wherein it is specifically provided that when management, control or capital of an enterprise in a contracting state, directly or indirectly controls management of an enterprise in another contracting state, then profit of that enterprise can be calculated after excluding conditions different from those, which would have been incorporated in a contract made between two independent entity. The AO noticed that there were eight agreements entered into between the assessee and the aforesaid two companies and only two agreements were specifically approved by the Government of India. He was of the view that even this approval did not prevent him to go into the question as to whether or not alleged expenditure should be allowed as a deduction. After examining the issue he formed the view that the payment made by way of commission/royalty was highly excessive in nature and there was no justificatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... llowed. Effect is that the Tribunal has held that the payment of commission was not huge or unreasonable and since it was a business expenditure the entire expenditure incurred by the assessee in both these years by way of payment of royalty/commission to the aforesaid two overseas companies is entitled for deduction. 4. Though, we shall take note of the order of the Tribunal in detail immediately hereafter, three significant aspects which influenced the Tribunal in arriving at the aforesaid decision are as follows:- (i) Royalty was paid on the basis of turn-over of the assessee/Indian company and the rate fixed was 3.5% of the turnover. The two overseas companies had given similar know-how to various companies world-wide with similar clause for payment of royalty and the average was 3.55%. Thus from the Indian companies, the royalty was fixed at lesser rate than the rate at which these two overseas companies were claiming royalty from other companies in other countries. (ii) The two agreements out of eight which were approved by the Reserve Bank of India provided stipulation as per which the Reserve Bank of India had authorized the assessee to pay royalty upto 5%. Thus, the Rese ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unt of royalty and disallowing part thereof as noticed above. The reasons given by the AO for invoking this provisions was that the two overseas companies to whom the payments were made are the companies in which the assessee has substantial interest as they are 100% subsidiaries of the assessees parent company and, therefore, as per the aforesaid provision, it was open to the Assessing Officer to form an opinion as to whether the expenditure was excessive or unreasonable having regard to the fair market value of the good, services or facilities for which the payment was made. 7. Section 91 of the Act deals with the arms length price. The reason for invoking this provision was again the same namely close relation between the assessee and the two overseas companies to whom the payment was made. 8. We may point out at this stage that Nestec S.A. is the parent company with its headquarter at Switzerland. It has various subsidiary companies. Nestec S.A. and Societe Des Produits Nestle S.A. Switzerland, are the 100% subsidiary company of the said company. Likewise, the assessee is the subsidiary company of the aforesaid parent company. In this manner, though there is no direct inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e. The technical assistant is to be provided from Switzerland in India by way of spot assistance as well as training of personnel of the assessee companies. Part C of the agreement pertains to Duties and Obligation of the assessee. Part-D deals with Consideration and it is under this part it is agreed that royalty to be paid by the assessee to the recipient companies would be 3.5 percent of the turnover. Part E stipulates Terms and Termination and Part F includes Miscellaneous Provisions . Clause 32 of the agreement under the caption Confidentiality binds the assessee to keep secret and confidential all information and documentation and, in particular, the compliance of this provision by the assessees staff, employees and workers. All the nine agreements are on same terms. The Tribunal in its detailed order took into consideration the aforesaid aspects and particularly the nature of know-how and services provided by the recipient companies to the assessee. Various documents and material supplied to the assessee in this behalf discuss in minute detail the services rendered and the benefit which accrued to the assessee as a result thereof. The remuneration which the assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... emendous value of nutrition in the foods that form our daily diets The science and technology of food was being given high priority and nowhere that was more true than at Nestle who had been in the food business for 125 years. Through constant Research and Development , Nestle sought to improve the quality of food and thereby quality of life itself. The learned counsel took us through the report of the Directors of the assessee company relating to structure of Nestle Research; Technological Development; Quality Assurance, Nestle India Access to Global Technology Bank. Referring to these reports, the learned counsel highlighted some examples of technology advancement directly relating to the business of the assessee company. For example, in 1992 weaning food manufacturing technology was enhanced through the introduction of Z line manufacturing process. This process was developed by NESTEC to meet the specific needs of overseas market and was found to meet the requirements of the Indian scenario. As a result, Nestle India was able to introduce weaning foods that ensured improved bioavailability of carbohydrates through the process of Enzymation, providing higher nutrition per meal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1996 with the single-minded objective of optimizing production cost while enhancing product quality so as to make Nestle product even more competitive in the market place. The team identified the following areas for detailed study : -Process improvement to ensure optimal usage of resources; -Improvement of operational efficiency; -Cost optimization. A series of small but critically important initiatives ranging from redesigning of laboratories to palletisation of raw materials and improvements in on-line analyses led to significant reduction in raw and packing material utilization, manufacturing and filling losses and labour manhours resulting in substantial savings and improved productivity and machine utilization. The pilot project in Moga having proved successful, the company intended to implement key learnings of the MIT in other factories. During later part of 1996, an international Sales and Marketing Improvement Team (SMIT) undertook a 4 months' SMIT exercise in India as a part of major global initiative of Nestle to enhance sales and marketing productivity on a worldwide basis. Following three critical areas were identified from the point of view of the grow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... logy Research Centres wrote technical know-how documents. The documents were validated through industrial usage and were continuously updated. With a strong centralized research, 7 development s and the very long experience in setting up and operation of factories, Nestle had been able to develop a vast knowledge base, which was essentially proprietary. To be able to impart this knowledge to the Nestle organizations entitled to receive it, Nestle had created the Technical Instruction system that guided the creation, distribution and management of know-how flow. These instructions covered product specific information, like Recipes and Manufacturing Instructions, Operational Aspects of factory operations as well as Safety, Environment Protection and Quality Assurance. 12. Taking note of all these aspects, the Tribunal came to the conclusion that the Assessing Officer was not correct in his observation that information and material asked by him was not provided by the assessee. On the contrary, by and large, the assessee furnished entire information, material and evidence as was asked for by the AO having regard to the nature of the technical know-how and other services provide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee has attacked the very rationale of the exercise done in these charts by the IT authorities. According to him, the quantum of remuneration could not, in any case, be linked with the profit. The profit was a derivative figure depending on various factors outside the direct and reasonable control of the technical assistance providers. Contracting for a fixed amount of royalty could be disastrous if the product did not click in the market. In the sale-linked agreement, the technical assistance providers interest in the success of the product was highest and ensured maximum assistance was received. Moreover, intangible benefit of technical assistance could not be gauged by the performance of the same year in which the investment in technology was made. The benefit could be gauged only over sufficiently long-term allowing the technical initiative to bear fruits. That apart, the learned counsel for the assessee pointed out that the working done by the Department was highly unreasonable inasmuch as the payments were compared with the profit of the company after payment of remuneration in question. The learned counsel, therefore, furnished a separate chart to show that even on imp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid was to be seen in the voluminous material and evidence filed by the assessee during the course of the assessment proceedings and the proceedings before us. It was totally inappropriate to test the reasonableness of the remuneration on the yardstick of profit of the year in which the payment was made. This issue required a long-term view to be taken. On careful consideration of the detailed submissions made by the assessee in this behalf and briefly enumerated by us in paras 37 to 65 of this order, we find ourselves in substantial agreement with the assessee. In the first instance, the assessee only had license to use the technology and, therefore, the assessee could not have continued the manufacture of any Nestle brand product without the consent of the parent company. We do not subscribe to the argument of the learned CIT (Departmental Representative) that as intellectual property rights were not recognized in India, the assessee could have snapped ties with the foreign company and carry on its business as before. We also find that the technical assistance provided by the parent company was all pervasive in the operations of the assessee-company and permeated into almost ev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on that several thousand Indian shareholders of the assessee-company were tremendously benefited. An investor who purchased 100 shares in 1970 had grown into shareholding of 3700 shares of the market Value of Rs. 19 lakhs after having received the dividend totaling to Rs. 2,66,653. The learned counsel argued that these aspects were required to be appreciated rather than merely suspecting that the remuneration for technical assistance was nothing but a camouflage to siphon away and repatriate the profits of Indian operations. On careful consideration, we see considerable force and justification in these arguments of the assessee. 13. The Tribunal also considered the question of applicability of Section 40 A( 2) and Section 92 of the Act and held that these provisions were not applicable. The matter was required to be looked into having regard to the provisions of Section 37 (1) of the Act and once it was found that it was a business expenditure, the same was allowable under the aforesaid provision. 14. In so far as nature of services provided against the consideration in the form of royalty paid by the assessee, the findings are recorded by the Tribunal on the analy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the Assessing Officer that, owing to the close connection between them, the course of business is so arranged that the business transacted between them produces to the resident either no profits or less than ordinary profits, which might be expected to arise in that business, the Assessing Officer shall determine the amount of profits, which may reasonably be deemed to have been derived therefrom and include such amount in the total income of the resident. Article 9: Associated Enterprises 1 Where- (a) An enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or (b) The same persons participate directly or indirectly in the management control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, And in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee; (vii) That there was no camouflage to siphon away Indian profits abroad; and hence disallowance of remuneration is not called for; 19. The Tribunal has held that the assessee having discharged the initial onus, burden shifted to the Revenue to show that the payment of royalty was excessive or unreasonable having regard to the legitimate needs of business or that the assessee has made less than ordinary profits and the Revenue has not discharged the said onus. The Tribunal has in general recorded clearly its findings of facts:- That no material or evidence has been brought on record by Revenue to substantiate applicability of above provisions; That the Revenue has not specified as to how much ordinary profit was supposed to be and basis of its determination, before treating royalty payment as excessive and unreasonable. 20. Coming to Section 92 of the Act, the CBDT has itself clarified in its Circular No. 14 dated 27.11.2001 that Section 92 of the Act does not apply in respect of payment of royalty etc which are not the part of regular business carried on between a resident and a non- resident. 21. This aspect is suitably dealt with by the Tribunal and ..... X X X X Extracts X X X X X X X X Extracts X X X X
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