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TMI Blog2014 (2) TMI 1230X X X X Extracts X X X X X X X X Extracts X X X X ..... he DRP') dated 30.09.2010. 3. In this appeal, Grounds of Appeal raised by the assessee read as under: -. "On the fact and circumstances of the case, and in law; 1. The Ld. Assessing Officer ('AO'), pursuant to the directions given by the Ld. Dispute Resolution Panel ('DRP'), erred in ruling that the transactions pertaining to royalty payment, export of certain finished goods and provision of marketing and sales support services have not been conducted at arm's length, and thereby making a transfer pricing adjustment of Rs. 11,475,285 to the income of the appellant. In the process, the Ld. DRP/AO erred in: For royalty payments: * considering the controlled royalty rate (prevailing between two of the appellant's Group companies) as a comparable to the rate of royalty at which the appellant paid royalty to its associated enterprises ('AE'), for benchmarking purpose under the comparable uncontrolled price ("CUP") method. * holding that the royalty amount (in connection with provision of technology) needs to computed by deducting the cost of raw materials from the sales value, thereby rejecting the methodology adopted by the appellant for computing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ) of the Act. The TPO vide his order u/s 92CA(3) dated 08.10.2009 proposed an addition of Rs. 1,14,75,285/- towards transfer pricing adjustment to the stated values of the international transactions undertaken with the AEs. The Assessing Officer has thereafter passed order u/s 143(3) r.w.s.144C(13) of the Act dated 25.11.2010 making an addition of Rs. 1,14,75,285/- in conformity with the order of the TPO dated 08.10.2009 and also in accordance with the directions of the DRP contained in its order dated 30.09.2010, who was approached by the assessee raising objections against the draft assessment order proposed by the Assessing officer on 08.10.2009. The aforesaid addition of Rs. 1,14,75,285/- made to the returned income is the subject-matter of dispute in the present proceedings. 5. Before we proceed to adjudicate4 the specific objections raised in the Grounds of Appeal, the background of the dispute can be summarized as follows. In the course of proceedings before the TPO, it was noticed that the assessee had entered into international transactions with its AEs on several aspects, which were segregated by the assessee into two segments, and were benchmarked by the assessee follow ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mined adjustment in respect of other segment i.e. Marketing and Sales support Segment of Rs. 11,75,224/-. As a result, the total adjustment on account of the transfer pricing analysis of the aforestated international transactions was determined by the TPO at Rs. 1,14,75,285/-, and accordingly the Assessing Officer, being bound by the directions of the TPO as per section 92CA(4) of the Act in respect to the determination of arm's length price, enhanced the returned income of the assessee by the said sum. The aforesaid action of the Assessing Officer, based on transfer pricing adjustment of Rs. 1,14,75,285/- determined by the TPO, is the subject-matter of dispute before us, in terms of the stated Grounds of Appeal. 6. In the above background, the rival counsels have been heard. The appellant has furnished voluminous Paper Books which inter-alia contain the submissions and material furnished to the lower authorities, and the same has been referred during the course of hearing. The learned CIT(DR) has also referred to the orders of the authorities below as well as the written submissions in support of the case of the Revenue. The rival submissions have been heard and the relevant mate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r reason that royalty paid by another Akzo group company i.e. Tianjin Akzo Nobel Peroxides, China (hereinafter referred to as 'TANPC') to 7th e same AE was @ 5%; and, therefore the TPO adopted the rate of 5% to determine the arm's length royalty payable by assessee to the AE on the export sales. The aforesaid position has since been affirmed by the DRP also. 8. On both the aforesaid aspects, the learned counsel for the assessee vehemently submitted that the lower authorities have erred in law as well on facts. Firstly, it is contended that the expression 'Net Sales', was required to be interpreted in terms of the standard terms and conditions prescribed by the Reserve Bank of India, which are applicable to all agreements pertaining to royalty payments on technology transfers to Indian companies. In this regard, our attention was drawn to the meaning of expression 'Net Sales' provided in para 3.3 of Chapter III of the Manual for Foreign Direct Investment Policy & Procedures issued by Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, Government of India, in terms of which only the cost of standard bought-out components and the landed cost of imported comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or assessment year 2007-08 respectively. In this context, it is sought to be made out that the period of the agreement and the products covered are different inasmuch as the Indian agreement is for seven (7) years whereas the China's agreement is for twenty (20) years. The products covered under the two agreements are also different inasmuch as the Indian agreement has 22 products whereas China's agreement has 33 products. It is submitted that where the period and the products covered are different, such transactions cannot be considered as comparable and reference has been made to the decision of the Pune Bench of the Tribunal in the case of Kirloskar Ebara Pumps Ltd. 47 SOT 20 (Pune) in this regard. Thirdly, it is sought to be made out that there is an error in the addition made on account of royalty inasmuch as a sum of Rs. 3,07,170/- h9a s been added in excess, even if the stand of the TPO was liable to be upheld. 10. On the other hand, the learned CIT(DR) appearing for the Revenue has referred to the orders of the authorities below in support of the case of the Revenue. The learned CIT(DR) submitted that the methodology adopted by the assessee for computing royalty payable to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons on this aspect. Before proceeding to adjudicate the addition of Rs. 91,66,061/- made on account of royalty payment, it would be relevant to note the pertinent facts. The appellant company is paying royalty to the AE for transfer of technology in terms of a Foreign Technology Collaboration agreement, which has been duly approved by the Government of India, a copy of such agreement is placed at pages 259 to 261 of the Paper Book. In terms of the said agreement, royalty payments are authorized on domestic sales and on export sales @ 5% and 8% respectively of 'Net sales', subject to taxes. The items of manufacture covered by the foreign collaboration are 'polymerization initiators', which is a product manufactured by the assessee for use as catalyst in manufacturing of polymers. The approval prescribes that the royalty payable shall be calculated in accordance with the provisions of the Foreign Exchange Control Manual of RBI and other subsisting instructions of Govt. of India/Reserve Bank of India. In this context, a reference has been made to the Chapter III of the Manual for Foreign Direct Investment issued by Department of Industrial Policy and Promotion, Govt. of India which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itted to the foreign collaboration, i.e. the AE, is as per the provisions of Foreign Exchange Control Manual of RBI. Notably, the approval by the Department of Indus1tr2ial Policy & Promotion (Secretariat for Industrial Assistance) dated 11.02.2005 itself prescribes that royalty shall be payable in accordance with the provisions of Foreign Exchange Control Manual of RBI and other subsisting instructions of the Govt. of India/Reserve Bank of India. There is no material on record to suggest that the calculation of royalty made by the assessee has been found to be violative of the respective provisions of FEMA or other subsisting instructions of the Govt. of India/Reserve Bank of India. In this background, a moot question which arises is whether the TPO is competent to rework the 'royalty payment' on the basis of his interpretation of the meaning of expression 'Net Sales', for the purpose of determining its 'arm's length price' under the CUP method. 13. In our considered opinion, the action of the TPO in re-working the amount of royalty payable based on his interpretation of the expression 'Net Sales' for the purposes of determining its arm's length price is not a right decision. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... actions as he actually found them. In our considered opinion, the aforesaid parity of reasoning laid down by the Hon'ble Delhi High comes into play in the present fact-situation also, as our following discussion would show. 15. In the case before the Hon'ble Delhi High Court, the TPO had applied the CUP method while examining the payment of brand fee/royalty, which also is the position in the case before us. The Hon'ble High Court referred to the OECD's "transfer pricing guidelines" for multinational enterprises and tax administrations, and reproduced paras 1.36 to 1.41 of such guidelines, which provide for "recognition of the actual transactions undertaken". Thereafter, the Hon'ble High Court opined as under :- "17. The significance of the aforesaid guidelines lies in the fact that they recognise that barring exceptional cases, the tax administration should not disregard the actual transaction or substitute other transactions for them 14 and the examination of a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises. It is of further significance that the guidelines discourage restructu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e two exceptions. Firstly, neither the Reve1n5ue has alleged and nor is there any material on record to suggest that the economic substance of the impugned transaction differs from its form. Secondly, there is no material on record to suggest that there is an arrangement between assessee and the AE made in relation to the impugned transaction which would differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. We say so for the reason that the entire gamut of royalty payment by the assessee to the AE is in terms of the Foreign Technology Collaboration agreement, which is duly approved by Govt. of India in terms of its Policy, which is applicable across the spectrum. Moreover, it is not the case of the TPO or even of the Revenue before us that the royalty remitted by the assessee to the AE has been found to be inconsistent or violative of the respective Government or RBI guidelines or any other authority in law. Thus, the TPO erred in calculating royalty payable on sales of Rs. 24,98,13,475/- as against Rs. 37,21,70,846/- considered by the assessee for the purpose of determining its arm's length price. 17. Even otherwise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Chloroformates can be retrieved." 18. Further, the difference between the key raw material and the finished goods have also been brought out as follows :- Criteria Chloroformate Finished Good storage conditions miscible/reactivity in water purity application appearance Hazard class ambient immiscible with water and reacts 98% to manufacture organic chemicals clear liquid Toxic (6.1) -15 Deg C max miscible with water 50 to 60% initiator to PVC polymerization white emulsion Oxidising agent (5.2) 19. On the basis of the above, it was sought to be canvassed that the chemicals sought to be classified by the TPO as constituent material are indeed raw materials. It is canvassed that the raw materials used by the assessee in its production process including the so-called 'constituent chemicals' classified by the TPO, undergo a chemical reaction in the manufacturing process, which is irreversible. It is further explained that the properties and usage of the finished goods achieved, namely, polymerization initiators, is quite, distinct from the raw materials consumed and none of the raw materials, including the so-called 'constituent chemicals' used in the manufacture of finished go ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring company, in which it is using imported raw materials, which are mixed and used to manufacture the final product. Should this raw materials also be treated at par with the imported components/ bought-out components? and be deducted from sale price to calculate royalty. Would highly appreciate your guidance on the same. Reply : Dear sir, In our opinion, No. Regards BB Sharma. Query : Thanks for the reply. Just to confirm your view on computation, does it mean that only bought out components on which no further processing is required in the company and are directly fitted into the final products are to be subtracted from the selling price? Your guidance in this regard would be highly appreciated. Reply : Dear sir: Your understanding seems to be correct Regards B B Sharma" 23. From the aforesaid, it is clear that what is liable to be considered as standard bought-out components are such material on which no further processing is required and are directly fitted into the final product; and, cost of such material only needs to be deducted from the sale price to compute the royalty payable. Applying the said clarification to the present situation, considering the manufacturing pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO in the present case is contrary to the prescription contained in sub-clause (i) of clause (a) of sub-rule (1) of rule 10B of the Rules. Ostensibly, in terms of subclause (i), the price charged or paid in a "comparable uncontrolled transaction" is to be identified for the purpose of determining the arm's length price of the international transaction being tested. It is starkly evident that in the present case, the comparable transaction picked-up by the TPO, namely, royalty payment by TANPC to the AE is a transaction between two related/associated enterprises and therefore it is a controlled transaction and not a "uncontrolled transaction". Such a transaction unde2r0taken between two controlled entities, in our view cannot be considered as a 'comparable uncontrolled transaction', as envisaged in clause (a) of sub-rule (1) of rule 10B of the Rules. Hence, on this count itself, in our view, the adjustment made by the TPO by considering 5% on export sales as an arm's length price of the international transaction of royalty payment has to fail. 26. Apart therefrom, factually speaking, assessee has brought out differences between the two agreements i.e. agreement between assessee an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the export sale of Trigonox 25C75 that the price charged from the AE has been found to be on a lower side than the price charged from a third party in domestic sale, whereas in respect of other products sold/exported to AEs the prices charged are higher than those charged from the domestic buyers. In this regard, a reference has been made to a comparative chart placed at page 253 of the Paper Book. Apart from the aforesaid, assessee pointed out before the TPO that Trigonox 25C75, which was exported to the AE at a price of Rs. 239/- per kg. was resold by the AE to the ultimate customer for an amount equivalent to Rs. 288/- per kg.; and, on this basis it is asserted that the price charged by the AE from the ultimate third party can be construed as the prevailing international market price, i.e. Rs. 288/- per kg. It is pointed out that considering the functions and the risks performed by the AE in such a transaction, it is to be understood that under no circumstances, assessee could have charged a price higher than the price prevailing in the international market i.e. Rs. 288/- per kg. minus the cost incurred by the AE for performing its f2u2nctions. Thus, the adjustment could at ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stand of the TPO has been affirmed by the DRP also and in the course of hearing before us, the learned CIT(DR) has sought to defend the same by adverting to the reasoning contained in the order of the TPO, which we have already been noted in the earlier paragraphs and is not being repeated for the sake of brevity. 31. Factually speaking, in the present case assessee has exported finished goods to its AEs and one such export was of a product Trigonox 25C75. In September, 2005 assessee exported 9000 kg. of Trigonox 25C75 at a price rate of Rs. 239/- per kg. to the AE, whereas the same product was also sold by the assessee on three occasions in July, August and September; 2005 to a party in India in quantities of 1000, 700 and 1000 kg. respectively @ Rs. 365 per kg.. For the said reason, the TPO considered the sale of the product to the Indian party as an internal comparable while applying the CUP method and determined the arm's length price of the export transaction by adopting the rate/price charged from the domestic party as the arm's length price. In our considered opinion, there is no infirmity on the part of the TPO in invoking the CUP method because the product sold is identi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted out that such economic benefit was to the tune of Rs. 10-11 per kg.. The aforesaid points brought out by the assessee, in our view, are bonafide grounds to permit adjustment to the comparable uncontrolled price being considered in order to benchmark the transaction of export. Notably, such adjustment is called for, having regard to the provisions of sub-clause (ii) of clause (a) of sub-rule (1) of rule 10B of the Rules and keeping in mind the aforesaid differences. A pertinent point has also been made out by the assessee that after export to the AE,2 5the same product has been ultimately sold by the AE to a uncontrolled party at a price, which can be taken to be the then prevailing international prices. Therefore, it is sought to be made out that the maximum price, which assessee could have realized on export of the product to a non-AE would be the prevailing international price, which was the price for which the AE sold the product to the ultimate customer. It was therefore pointed out that considered in the said light, the adjustment permissible in order to bring the transaction to the level of arm's length price can it best be restricted to the difference between the price c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee, it was the case of the assessee before the TPO that the international transaction relating to receipt of intending commission and marketing support fees was at an arm's length price. However, during the course of the proceedings before the TPO, assessee was required to give the functional details of the comparables as well as PLI based on the single year financial data pertaining to the financial year under consideration i.e. 2005-06. On that basis, it was found that for the two of the comparables, the data for the year under consideration was not available in public domain whereas in case of a third comparable it was found that the comparable functions of marketing business operations was discontinued. Accordingly, the three comparables were rejected. The fourth comparable, namely, Alfred Herbert (India) Ltd. (in short "Alfred") was found to be engaged in marketing and sale support activity of a different product and had incurred losses and therefore, it was sought to be rejected. This left only one comparable which was considered acceptable by the TPO, namely, Priya International Ltd. (intending segment) with the PLI of 22.58%. Assessee objected that it could not be appro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... engaged in similar functions of sales and marketing, albeit of machines, tools and spares. According to the assessee, the product differentiation is no ground to say that the said concern is functionally incomparable because in the TNM method, it is the nature of activity which is material and not the products. The learned counsel also assailed the argument of the TPO that the said concern was incomparable for the reason that assessee is a cost-protected, which is not so in the case of Alfred. According to the learned counsel, the approach of the TPO is inconsistent because even the concern M/s Priya International Ltd. (intending segment) which has been selected by TPO is not a cost-protected entity and yet it has been considered as a comparable concern. It was thus contended that the rejection of Alfred was unjustified. 36. With regard to the exclusion of IDC (India) Ltd., the learned counsel submitted that the said concern was also taken as a comparable concern while benchmarking the international transaction of the assessee in the subsequent assessment year of 2007-08 and the said position has been accepted by the TPO. It was therefore, contended that the said concern has been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from the list of comparables. 40. Now, we may consider the exclusion of the concern M/s IDC (India) Ltd. from the list of comparable, which is being agitated by the assessee. Firstly, there is no dispute to the position a3s0serted by the assessee that the said concern has been considered as a comparable in subsequent assessment year 2007-08; and, there is also no change in the activity profile of the said concern. Secondly, we see from the discussion in para 8.4(5) of the order of the TPO that the said concern alongwith two concerns, namely, Gaur & Nagi Ltd. and Agrima Consultants International Ltd. were rejected for being functionally on the ground that they were engaged in providing support services with respect to market research (market intelligence function and related services). In this connection, we find that in so far as , Gaur & Nagi Ltd. and Agrima Consultants International Ltd. are concerned, the said concerns are indeed engaged in providing an array of services in the field of market research and intelligence gathering, which is quite distinct from the activity of marketing of products. Therefore, while the TPO was justified in rejecting M/s Gaur & Nagi Ltd. and Agri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ICRA Online Ltd. is engaged in the business of research and support in capital markets (primarily assisting the mutual funds) and providing research reports. It is also emerging from record that the said concern is an 'Information services and technology consultation' provider and its products include research and analysis, financial health management and operations management. Considering the aforesaid functional profile of the said concern, in our view, assessee is justified in asserting that the same is functionally incomparable with the nature of activity being performed by the assessee in its Marketing and Supp3o2rt Services segment. The nature of activity being performed by the assessee in its Marketing and Sales support Segment have already been noted by us in the earlier paragraphs and on that basis we uphold assessee's plea for exclusion on ICRA Online Ltd. (Information Services Segment) for the purposes of benchmarking its international transaction of Intending commission and marketing support fee for the assessment year 2007-08. Accordingly, the TPO is directed to re-work the adjustment on account of the Marketing and Sales support Services segment by excluding ICRA Onli ..... X X X X Extracts X X X X X X X X Extracts X X X X
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