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2015 (8) TMI 610 - ITAT HYDERABAD

2015 (8) TMI 610 - ITAT HYDERABAD - TMI - Transfer pricing adjustment - DRP deleted the ALP adjustment proposed by the AO - disallowance of payment of royalty and technical service fee to M/s. Kirby Building Systems, Kuwait analysed under the provisions of transfer pricing - Held that:- The assessee had entered into international transactions for payment of royalty and fee for technical services vide agreement dated 1.4.2000. Further we find that this agreement had undergone several amendments a .....

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e was paying the amount as per the agreements. For coming to the conclusion, the Tribunal relied upon the decision of the Hon’ble Delhi High Court in the case of CIT vs. EKL Appliances (2012 (4) TMI 346 - DELHI HIGH COURT). This decision of the Tribunal was also followed by the Coordinate Bench of this Tribunal in assessee’s own case for A.Ys 2008-09 and 2009-10 holding that the royalty paid by the assessee was at ALP.

DRP has only followed the decision of the ITAT in assessee’s own c .....

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dhavi Devi, J.M. This is a Revenue appeal for the A.Y 2010-11 against the order u/s 143(3) r.w.s. 144C(1) of the I.T. Act, 1961, dated 30.01.2015. 2. Brief facts of the case are that the assessee company is engaged in the business of manufacture of pre-engineered building system products, filed its return of income on 13.10.2010 declaring total income of ₹ 6,40,81,725. On verification of the record, the AO observed that assessee has entered into international transactions exceeding ₹ .....

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agreement, assessee paid royalty @ 7.5% on the sales amounting to ₹ 9,39,74,409 and ₹ 61,77,041 towards technical fee. He observed that royalty and fee for technical services are transactions for intangible services and therefore, TPO accepted the CUP method adopted by the assessee as the most appropriate method and further observed that two independent comparables i.e. M/s Cold Steel Corporation and Tiger Steel Engineering (P) Ltd were adopted by the TPO in the assessee s own case i .....

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assessee on job work basis. Therefore, he came to the conclusion that assessee has engaged third parties to get the work done on the projects undertaken in a significant way, meaning thereby, that the work involved is a low end job which does not require any speciliazed skills. Therefore, he was of the opinion that there was no need for obtaining any technical services by the assessee from its AE. As regards payment of royalty, the TPO held that unless it is shown that tangible and direct benefi .....

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unt of intangible/royalty and technical service fees is nil. He accordingly made adjustment of the entire amount of Rs.,9,39,74,409 and ₹ 61,77,041 u/s 92CA of the I.T. Act. Similarly, the TPO also made adjustment of ₹ 1,07,99,889 as an ALP adjustment on reimbursement of expenses received. On the basis of the said T.P. order, AO proposed the draft assessment order dated 19.03.2014. Against the said order, assessee preferred objections before the DRP. The DRP, vide order dated 24.12.2 .....

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to the same, the final assessment order was passed u/s 143(3) r.w.s. 144C(1)of the Act without making any TP adjustment on royalty and reimbursement of expenses. Against this order, dated 30.01.2015, the Revenue is in appeal before us. 4. The ld DR, while supporting the Transfer Pricing order, submitted that the DRP has erred in holding that the royalty payment/fee for technical services is not warranted, though the TPO has held that the applicant was not able to substantiate that any benefit wa .....

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egard to the rival contentions and also the material on record, we find that the assessee had entered into international transactions for payment of royalty and fee for technical services vide agreement dated 1.4.2000. Further we find that this agreement had undergone several amendments and the assessee had started paying royalty only from the P.Y 2005-06 onwards. Therefore, the ALP adjustment of these transactions has arisen only from P.Y 2005-06 onwards. This Tribunal, in assessee s own case f .....

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1070 of 2011 dated 29.03.2012). This decision of the Tribunal was also followed by the Coordinate Bench of this Tribunal in assessee s own case for A.Ys 2008-09 and 2009-10 holding that the royalty paid by the assessee was at ALP. The relevant paragraphs are reproduced hereunder for the sake of ready reference: 4. Ground Nos. 1 to 8 pertain to the disallowance of payment of royalty and technical service fee to M/s. Kirby Building Systems, Kuwait analysed under the provisions of transfer pricing. .....

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e of the AE International transaction Value in INR Kirby Kuwait 1. Payment of royalty & technical services fee 137,037,502 2. Payment of interest (ECB in Kuwait Dinar) 1,473,502 3. Payments towards reimbursement of expenses 657,120 KIMMCO Purchase of insulating material 19,429,932 Alghanim Mauritius Payment of interest on (ECB in USD) 1,031,517 5. The TPO vide order dated 30.10.2009 accepted the operating transactions consisting of purchase of insulating material and of payment of interest, .....

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has debited an amount of ₹ 17,71,37,206/- towards royalty at the rate of 7.5% on sales. During F.Y. 2004-05, the taxpayer has paid royalty at ₹ 6,77,67,700/- to Kirby, Kuwait (AE) at the rate of 3.5% on sales. As per the agreement entered by and between the taxpayer and it s AE at clause-4, the rates for payment of royalty are given. Except that, nothing is mentioned. What is the basis for which royalty is paid by the taxpayer remained unsubstantiated. In its reply dated 10.03.2009, .....

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y to subsequent years. However, the amendment in the royalty rates and the payments terms are subject to the condition that the royalty payments will not exceed the potential outflow as agreed in the original TSA. Further, in respect of the lump sun technical fee, the sum of USD 2,000,000 which was agreed as per the original TSA, has not been revised but the payment terms have been amended to defer the payment over a certain number of years up to 2017. Taxpayer failed to furnish any FAR analysis .....

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r not paying royalty by the taxpayer between the years 2000 to 2004 is that there were no profits made during the said financial years. This is not correct. In fact, for F.Y. 2003-04, the taxpayer has earned a net profit margin of 6.67%. The claim of the taxpayer that there is a substantial expansion of the manufacturing facility during the F.Y. 2003-04 is also not correct. No significant expansion took place during that year. Plant machinery valued at ₹ 2,64,35,261 is only added. A net pr .....

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reference to the benefits derived and services rendered. The taxpayer failed to bring out any evidence in support of the technical services actually received. Hon ble Supreme Court in the case of Union of India vs. Gosalia Shipping P. Ltd., 113 ITR 307 (SC) held that : It is true that one cannot place over reliance on the farm which the parties give to their agreements or on the label which they attach to the payment due from one to other. One must have regard to the substance of the matter and .....

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analysis thereon, the only inference that can be drawn is that these two transactions that is payment towards royalty and technical services is that they are not at arms length. In the guise of these payments, the taxpayer is shifting profits to no tax jurisdictions like Kuwait and Mauritius, thereby enriching themselves without paying taxes that are due in the country where the taxpayer operates. The profits declared by the taxpayer are not comensurating with the functions performed and risk as .....

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in industrial sector. PESBs are not consumer products which can be bought off the shelf from any store. Also it is important to note that brand value is developed from the contributions made by all the group entities of MNEs. Therefore, Kirby, India has developed its own brand value by spending huge amounts on marketing, development and advertisements as discussed in the earlier part of this order. Significant costs have been incurred by Kirby, India in marketing of its product in the country. .....

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ional group. No payment on account of brand value by the taxpayer to its AE is not justified. In view of the above discussion, it is concluded that the payment made by the taxpayer to its A.E. on account of technical services is excessive as already huge payments were made in the past several years. Neither taxpayer nor its AE could substantiate the actual technical services rendered, costs incurred/contributed, benefits derived. The arms length price of the payment made towards technical servic .....

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ransactions of the AE and various agreements entered by the assessee with AE with reference to payment of technical fee and royalty gave partial relief by stating as under : 8.3 After going through the entire material provided by the taxpayer and after extensive discussion of the TPO, we are of the view that Kirby India has established a plant In the outskirts of Hyderabad with technical assistance from its AE. Definitely, the AE has to be paid in terms of royalty and technical knowhow fee for t .....

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-01 2,43,259 Total 4,29,16,118 8.4. As seen from the above table, the taxpayer during the last six years has debited to the Profit & Loss Account to the tune of ₹ 4,29,16,118/- on account of technical services. The benefit derived by the taxpayer from the above technical services, we are of the view is adequately compensated and hence further technical fee payment in this year is not necessary. The action of the TPO in taking technical fee payable for this year as nil is upheld. In res .....

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be a tendency to shift the profit from the taxpayer to its parent companies. Now the question is how to quantify them. During the FY 2004-05, the taxpayer has paid the royalty @ 3.5% on sales of ₹ 6,77,67,700/-. We are of the view that during this year also the royalty payment of 3.5% on sales would meet the requirement of ALP. To this extent, the TPO s report is modified i.e. ALP in respect of royalty payment is calculated as under : Price Received vis-a-vis the Arms Length Price: The pr .....

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s.92CA: (1) In respect of payment made towards technical services. Rs.59,20,536 (2) In respect of payment made towards royalty Rs.9,44,73,176 Total Rs.10,03,93,712 7. Thus the assessee has got partial relief from the DRP. Therefore, it has raised various grounds on the denial of claim of payment of technical services and restriction of royalty to the AE in its grounds 1 to 8. 8. Ld. Counsel drew our attention to the activities of the assessee company, reliance on technical expertise of Kirby Bui .....

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ved by the RBI. However, vide amended agreement dated 07.09.2001 it was understood that lump sum amount of 2 Million USD would be paid in 5 equal installments beginning from the year December, 2002 with modified terms of payment of Royalty and Technical fee. Since the assessee company was incurring losses and was in requirement of working capital, there was further amendment on November 12, 2002 with further modifications. Since assessee paid only an amount of 0.4 Million US dollars as on that d .....

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submitted that in the original agreement dated 01.04.2000 royalty was payable on domestic sales at 2.5% in the first year and 5% from second year i.e., 2002 onwards up to 31.03.2007. However, assessee has not paid any royalty in the year 2000-2001 and vide agreement dated 07.09.2001, the terms were changed to pay royalty at 5% on domestic sales and 5% on export sales from the year 2002 to March, 2007. In spite of that, assessee did not pay any royalty in the years 2002 and 2003. Therefore, vide .....

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has claimed the royalty at 7.5% on domestic sales and 8% on export sales. 10. It was submitted that assessee has never paid any royalty at 3.5% on domestic sales and to that extent both TPO and DRP wrongly considered the payment at 3.5% and allowed the amount at that rate. It was submitted that royalty in A.Y. 2005-06 was paid at 7.5% on domestic sales which was allowed. As far as the technical knowhow is concerned, this amount was payable in a lump sum amount initially which was deferred and o .....

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d the amount of Royalty without any comparative study under various methods prescribed under the provisions for examining the arm s length price of the transactions entered into by the assessee with its AE. Since the TPO has no jurisdiction to examine the allowability of royalty claim, action of the TPO/DRP is not sustainable. For this proposition, the Ld. Counsel relied upon the decisions of the Hon ble High Court of Delhi in the case of CIT vs. EKL Appliances Ltd. 1068 of 2011 dated 29.03.2012 .....

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hout examining the arms length price of the transaction. 12. Coming to the observations of the TPO that there was shifting of profits to no tax jurisdiction, it was submitted that this argument cannot be accepted in view of the provisions of T.P. and also on further fact that assessee has paid the taxes on the amounts in India. It was submitted that the royalty and technical fee payable are on net basis. Therefore, assessee has grossed-up the amounts and to an extent of about 32% assessee has pa .....

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5% of domestic sales or 8% of export sales, as per the policy of the RBI there are various exclusions in considering the turnover. Therefore, the effective date of royalty was much less whereas, the DRP has approved the rate at 3.5% on the gross domestic sales. Therefore, there is a little variation in the amounts taken. 14. Summarising the arguments, Ld. Counsel submitted that DRP/TPO has no jurisdiction to restrict the amount to NIL. Ld. Counsel made various propositions as under and as suppor .....

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w Delhi ITA.No.5857/Del/2012 dt. 14.06.2013 ii. The TPO has no jurisdiction to question the business prudence of the assessee in paying various royalties/technical knowhow fee. (i) Johnson & Johnson Ltd., Mumbai vs. CIT-LTU, Mumbai ITA.No.83/Mum/2011 dated 05.02.2014. (ii) Reebok India Co. vs. ACIT, New Delhi ITA.No.5857/Del/2012 dt. 14.06.2013. iii. The TPO has no jurisdiction to disallow the entire amount without determining the ALP (i) SC ENVIRO Agro India Ltd., Mumbai vs. DCIT 3(3), Mumb .....

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essee is also not relevant for considering the payment of royalty and technical knowhow fee and relied on the following case laws (i) DCIT, Circle1(1), Hyderabad vs. M/s. Air Liquide Engineering India P. Ltd., Hyderabad ITA.No.1040/Hyd/2011 etc., dt. 13.02.2014 (ii) ACIT, Cir.4, Ahmedabad vs. Hitachi Home & Life Solutions (India) Ltd., ITA.No.2361 & 2362/Ahd/2008 etc., dated 24.09.2013. 15. Learned D.R. however, relied on the detailed orders of the TPO and DRP to submit that there is no .....

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that the assessee has paid cumulative royalty as percentage of cumulative sales at 3.75% up to A.Y. 2009-2010. It was submitted that the payment of technical knowhow and royalty should be allowed in full. 17. We have considered the rival contentions and examined the orders of the authorities, documents placed on record and relevant case law relied upon. Kirby Building Systems India P. Ltd., is a wholly owned subsidiary of Alghanim Industries, a Kuwait based Multi-Billion Conglomerate. It is one .....

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actices. All the buildings designed by Kirby are custom designed using latest domestic/international codes and standards such as IS, MBMA, AISC, AISI and AWS. PEB technology has various advantages being flexibility in expansion, faster installation, energy efficient and practically maintenance free with superb quality and also earthquake resistant. It has applications starting from factories and warehouse to air-craft hangers, stations, ship yards, work-shops, Stadiums etc. Assessee indeed pione .....

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ee did not remit any of those amounts in those years and the agreement was amended periodically. As stated above in the facts of the case, in the impugned year assessee has paid $ 1 lakh dollars as technical knowhow fee and royalty at 7.5% on domestic sales as per the agreements entered into and approved by the authorities. 19. In the guise of examining the payments under T.P. provisions, it is noticed that the TPO has not analysed these payments either under TNMM method or under any other metho .....

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s on 01.04.2000 much before the T.P. provisions came on statute. It may be another reason that assessee has revised the agreement and paid subsequently, partly in the impugned year, but that does not prevent assessee claiming expenditure which was necessary for its business operations in view of the agreement entered at the time of establishing the unit in India. Had there been no revision of the agreement, the payment of technical knowhow fee would have been over by the year 2002 itself. Assess .....

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wing the amount on the basis of ALP to be determined under the provisions. 20. The Hon ble Delhi High Court in the case of CIT vs. EKL Appliances ITA.No.1068 of 2011 and 1070 of 2011 dated 29th March, 2012 considered similar issue whether the TPO has power to restrict in determining the ALP at NIL under the provisions of T.P. when he was supposed to have determined the arms length price of the international transaction. The Hon ble Delhi High Court after examining the facts of the case held unde .....

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ness and it is not for them to tell the assessee as to what expenditure the assessee can incur. We may refer to a few of these authorities to elucidate the point. In Eastern Investment Ltd. v. CIT, (1951) 20 ITR 1, it was held by the Supreme Court that there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of the Income Tax A .....

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the Revenue. It was further observed that the rule that expenditure can only be justified if there is corresponding increase in the profits was erroneous. It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand, (1938) 6 ITR 636 that expenditure in the course of the trade which is un-remunerative is none the less a proper deduction if wholly and exclusively made for the purposes of trade. It does not require the presence of a receipt on the credit side to justify the .....

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e of whether there is receipt of income or not. That is the plain requirement of proper accounting and the interpretation of Section 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income. It is noteworthy that the above observations were made in the context of Section 57(iii) of the Act where the language is somewhat narrower than the language employed in Section 37(1) of the Act. This fact i .....

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es of business in order to merit deduction. Pursuant to public protest, the word necessarily was omitted from the section. 21. The position emerging from the above decisions is that it is not necessary for assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not necessary for assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same yea .....

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the expenditure was un- remunerative or that in view of the continued losses suffered by assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire e .....

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laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised. 23. Apart from the legal position stated above, even on merits the disallowance of .....

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5 years from 1998 to 2003 with relevant figures have been given before the CIT (Appeals) and they are referred to in a tabular form in his order in paragraph 5.5.1. In fact there are four tabular statements furnished by assessee before the CIT (Appeals) in support of the reasons for the continuous losses. There is no material brought by the revenue either before the CIT (Appeals) or before the Tribunal or even before us to show that these are incorrect figures or that even on merits the reasons .....

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Delhi High Court in the above said case equally applies to the facts of the case. What TPO has done in the present case is to hold that assessee need not pay any royalty or technical knowhow fee to the AE. Even though DRP has partly modified the payment of royalty, what we noticed is that they also made a mistake in allowing only 3.5% of royalty when in fact, there is no such claim in any of the earlier years. As submitted by the Ld. Counsel in the course of arguments/presentation before us ass .....

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cise duty) (Rs.Cr.) PBIT - Rs. Cr. Royalty payment Rs. Cr. Technical fee payment Rs. Cr. Royalty (as % sales) Cumulative royalty as % of cumulative sales 2001-02 47.15 -1.69 - 0.02 0.05% 0.05% 2002-03 76.32 5.66 - 0.11 0.14% 0.11% 2003-04 85.81 6.17 - 0.64 0.74% 0.37% 2004-05 100.68 8.78 - 1.03 1.02% 0.58% 2005-06 193.34 17.46 5.36 1.78 3.69% 1.78% 2006-07 231.69 13.05 13.26 0.45 5.92% 3.08% 2007-08 282.78 23.01 15.82 0.44 5.56% 3.79% 2008-09 390.54 29.33 15.75 0.39 4.14% 3.88% 2009-10 816.69 54 .....

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lmost equivalent to the royalty claimed by the assessee on net sales basis. It was submitted that as percentage of sales, royalty payment in the impugned year was only 5.92%. Be that as it may, we are not in a position to approve the action of the A.O. / DRP in restricting the royalty and total denial of Technical services fee without any basis at NIL under the guise of T.P. provisions. In view of this, we are not in agreement with the action of the TPO / DRP. 20.4. In the course of arguments, L .....

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st of other decisions as stated in the submissions above to substantiate various propositions. Suffice to say that we have considered various legal principles on the issue. We are of the opinion that apart from legal position, even on merits the disallowance of entire technical knowhow payment and part disallowance of royalty payment to AE was not warranted. 21. There is one more aspect to the above issue. The agreements were periodically approved by RBI and by Ministry of Industry and assessee .....

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