TMI Blog2015 (1) TMI 921X X X X Extracts X X X X X X X X Extracts X X X X ..... n, the perfect approach for indirectly bench marking royalty payments is to bench mark the profit margin left in the tested party, after payment of lump sum fee or royalty with the profit margins of comparable uncontrolled companies. Therefore, we are of the opinion that even if the royalty payment is to be analyzed separately, TNMM is the most appropriate method for determining the ALP. The fact that the assessee was engaged in the activity of manufacture itself proves the use of technical know-how by the assessee and therefore, as held by the Hon’ble Delhi High Court in the case of EKL Appliances (cited supra), the AO or the TPO cannot question the commercial expediency of the assessee or the quantum of benefit the assessee derived while making the payment. We agree with this contention of the assessee. Remand the issue for determining the ALP under the TNMM, the assessee as well as the Revenue have to search for comparable companies. Therefore, we remit this issue to the file of the AO/TPO to determine ALP of royalty by adopting TNMM after giving the assessee a fair opportunity of hearing. - Decided in favour of assessee for staistical puroses. - IT(TP)A No1642/Bang/2012 - - ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e year 2002 for the manufacturing of automatic front axle, rear axle and the propeller shaft. During the financial year ending 31/03/2008, the assessee entered into various international transactions with its Associated Enterprises (AEs). One of the international transactions entered into with its AEs includes payment of royalty for using the technology and technical know-how. The assessee aggregated all the international transactions and adopted TNMM as the most appropriate method and arrived at the operating margin on sale at 9.87%. The AO accepted all the international transactions of the assessee with its AEs to be at arms length except the payment of royalty. He treated the payment of royalty to be a separate kind of transaction and held that TNMM is not the most appropriate method for determination of the ALP. He adopted the CUP method and also applied the benefit test and arrived at the ALP of the royalty payment at nil . The assessee had also filed a comparability analysis as per CUT method but the same was not accepted by the TPO and treated the royalty at nil . Accordingly, the transfer pricing adjustment was made and the entire payment of royalty was brought to tax. Ba ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Description of the International Transaction INR in 000's Benchmarking Methodology Purchase of raw materials, components and consumables 6,60,217 Transactional Net Margin Method (TNMM) Purchase of Capital Assets 75,944 Payment of royalty 2,72,309 Payment for technical assistance 18,828 Payment of IT support fee 4,905 Payment of warranty claims 19,311 Payment of training fees 5,087 Payment towards reimbursement of expenses 5,032 Sales Return 286 The AO observed that these transactions are purchase of raw materials, components and consumables which are used in manufacturing of the rear axles, front axles and the propeller shafts for the multi utility vehicles manufactured by Toyoto Kirloskar Motor Pvt. Ltd., and the expenses are towards related and connected processes of man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ethod. Thereafter, he held that the tax payer did not produce any primary evidence/documentation on how the royalty rate is fixed or the benefit received by the assessee for fixing the royalty as under: i) Domestic sales - 3% of sales ii) Export sales - 5% sales He observed that the royalty paid by the assessee is 40.76% of operating profits before royalty which is highly disproportionate to the profits earned using such technology. He further observed that even after paying such huge amounts as royalty, the assessee s margin is only 6.71% on sales, which is lesser than the average margin of 8.29% of the comparable companies (who are not paying similar royalty payments and also do not have significant intangibles) considered by the TPO. Thus, he came to the conclusion that the assessee did not get any tangible commercial benefit in terms of improved profitability even after paying for technology know-how and the payments are only to siphon off the profits from India with minimum incidence of tax. He also considered the reasonableness of the royalty paid by the assessee and held that it is not proved. He, therefore, determined the ALP of the royalty payment at Nil and mad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... manufacture is interlinked to the manufacturing process and therefore is required to be tested under TNMM. He submitted that the TPO has not provided any independent transactions which are similar or identical in nature that reflects the characteristics of the services provided by the AE s to the assessee for application of CUP method. He submitted that even assuming that CUP method is to be applied, the TPO has to conduct comparability analysis, which is an essential element of TP analysis and for failure to do so, the TP adjustment cannot be substantiated. 8. As regards the adoption of the TNMM method for the aggregation of the transactions, he submitted that the payments of royalty and technical services are under the same technical agreement and therefore different approach cannot be adopted for these two transactions without giving any valid reasons for doing so. He submitted that the technical services have been aggregated with the other international transactions while different approach has been adopted for determination of ALP for royalty. He further drew our attention to the fact that the TPO has himself aggregated all the international transactions of the assessee du ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uthorities cannot determine the business needs i) Dresser Rand India Pvt. Ltd. vs. Addl. CIT (ITA No.8753/Mum/ 2010) ii) SC Enviro Agro India Ltd. vs. DCIT (ITA No.2057 2058/Mum/ 2009) 10. The learned DR, on the other hand, supported the orders of the authorities below and submitted that each of the international transactions has to be considered separately for the determination of the ALP and having regard to the peculiar nature of the royalty transactions, the TPO has rightly held that payment of royalty requires separate analysis and has rightly adopted CUP method. As regards the assessee s contention that the TPO, having held that the CUP is the most appropriate method, ought to have conducted the search for comparables and, therefore, determined the ALP, he submitted that if the same is to be accepted, then the matter should be remanded back to the authorities below for determination of the ALP under CUP method. 11. Having heard both the parties and having considered their rival contentions and the material on record, we find that the following questions arise for our consideration. 1) Whether the payment of royalty is interlinked and interconnected with the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... into one deal. One would usually want to consider the deal in its totality to understand how various elements relate to each other, but the components of the composite package deal may or may not, depending on the facts and circumstances of each case, need to be evaluated separately to arrive at the appropriate transfer price. Aggregation issue may also arise when looking at uncontrolled comparables. This is because third party information is not often available at the transaction level. In such circumstances, entity level information is the only recourse available. Therefore, whether ALP-principle is to be applied on a transaction by transaction basis or on an aggregation basis depends on the facts of each case and is not universally or generally applied in all composite contracts involving multiple transactions. 14. In the case before us, the assessee has entered into various transactions which include purchase of raw-material, components and consumables, capital assets and payment towards royalty, technical assistance, IT support fee, payment of warranty claims, training fee, reimbursement of expenses etc. It is the case of the assessee that all these transactions are inter- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 15. As regards the most appropriate method for determining the ALP of the royalty is concerned, we find that the AO has adopted the CUP method whereas the assessee has adopted the TNM Method. Now, between the two, which is the most appropriate method? Each TP method is suitable only for certain transactions. Under CUP method, higher degree of product similarity and similarity of products generally is required and it will have the greatest effect on the comparability. In addition, because even minor differences in contracted terms or economic conditions could materially affect the amount charged in an uncontrolled transaction, Comparability under this method depends on close similarity with respect to these factors or adjustments to account for any differences. Therefore, CUP method is the most direct and reliable method for determination of ALP for the controlled transaction if an uncontrolled transaction has no differences with the controlled transactions that would affect the price or if there are only minor differences that have a definite and reasonably ascertainable effect on price and for which appropriate adjustments can be made. Per contra, Transactional Net Margin Met ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ercise and may require a flexible approach that need not be strictly based on specified transfer pricing methods. Therefore, in such a situation, the perfect approach for indirectly bench marking royalty payments is to bench mark the profit margin left in the tested party, after payment of lump sum fee or royalty with the profit margins of comparable uncontrolled companies. The decisions relied upon by the learned counsel for the assessee as enumerated in the preceding paragraph No.9 above also support this view. Therefore, we are of the opinion that even if the royalty payment is to be analyzed separately, TNMM is the most appropriate method for determining the ALP. 16. To demonstrate that the price paid by the assessee towards royalty is at arm s length, the assessee has filed copies of the agreement of the AE with its other group companies as well where the rates of royalty are the same. Thus, according to the learned counsel for the assessee, the payment is at arm s length. However, we find that even by adopting the CUP method, the AO has not brought on record any of the comparable companies to arrive at the ALP but has only applied the benefit test to determine the ALP at ..... X X X X Extracts X X X X X X X X Extracts X X X X
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