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2016 (6) TMI 123 - ITAT DELHI

2016 (6) TMI 123 - ITAT DELHI - TMI - Transfer pricing adjustment - international transaction of 'Payment of royalty’ - whether no addition on account of transfer pricing adjustment is permissible as the AO has not made any disallowance u/s 37(1)? - Whether application of the TNMM on entity level should be upheld covering the international transaction of payment of royalty? - MAM - Held that:- Coming to the determination of ALP of this international transaction under the CUP method, we find that .....

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he TPO to find out relevant comparables and proceed to determine the ALP accordingly.

Coming back to the TPO’s opinion about nil ALP of the payment of royalty, we find that the DRP has accepted the marginal use of technical know-how by the assessee from its AE, for which it directed to adopt 0.25% on sales as the ALP of royalty payment in respect of this model. It is this ad hoc approach of the DRP which has been turned down by the Tribunal for the earlier years leading to the restor .....

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for a fresh determination of the ALP of the international transaction of 'Payment of royalty’ for model 3DX by applying the CUP method after affording a reasonable opportunity of being heard. - Decided in favour of assessee for statistical purposes. - ITA No.1075/Del/2016 - Dated:- 31-3-2016 - SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM For The Assessee : Shri M.S. Syali, Sr. Advocate and Shri Tarandeep Singh, CA For The Department : Shri Amrendra Kumar, CIT, DR ORDER PER R.S. SYAL, AM: This .....

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ned Indian subsidiary of J.C. Bamford Excavators Ltd., UK. It commenced its operations in the year 1979 and is engaged in the manufacture of Earthmoving and Construction equipments. The assessee reported 19 international transactions for the year in question in Form No. 3CEB including Payment of royalty with transacted value of ₹ 185,76,44,174/-. The assessee used the Transactional Net Margin Method (TNMM) to benchmark its major international transactions. Profit Level Indicator (PLI) of O .....

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8377; 164,74,23,297/- in respect of product 3DX to its associated enterprise (AE) @ 5% of domestic sales and 8% of export sales. A show cause notice was issued requiring the assessee to explain as to why such royalty of ₹ 164 crore and odd was paid on model 3DX machine which was nothing, but replication of model 3D, whose patent expired long back. At this stage, we consider it relevant to mention that the view point of the TPO that the assessee did not pay any royalty on model 3D during th .....

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nce of any agreement between the assessee and its AE and not due to any unexpired patent. Coming back, the assessee was also called upon by the TPO to file agreements along with necessary annexures for products 3D and 3DX and also to substantiate new inventions/improvements in product 3DX vis-à-vis product 3D. The assessee furnished such details along with agreements and also a technical report of some professor from IIT Delhi on the study made by him on the features of models 3D and 3DX. .....

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ive non-transferrable license in India to manufacture, assemble, use and sell products and, for that purpose, to use the know-how inventions covered by the patent rights. The assessee still further submitted that it did not own any patent rights in India for 3D and the design registrations were done in its name to protect the potential infringements of designs in India. The TPO observed that there was a change in the approach of the assessee in this year vis-à-vis the earlier years inasmu .....

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ethod for the royalty payment transaction; new product 3DX is existing old product 3D with the same Indian manufacturer of Kirloskar Ltd.; and the assessee had not paid any royalty on product 3D from the year 1987 to financial year 2005-06. As regards the use of the CUP method by the assessee for benchmarking the international transaction of Payment of royalty on 3DX for the year under consideration, the TPO did not find any convincing reasons to accept three comparables chosen by the assessee o .....

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ll the financial year 2005 on one hand and product 3DX on the other on which the said royalty has been paid and the further fact that the assessee itself carried out R&D activity in respect of 3DX model during earlier years, the TPO came to hold that no independent person would have paid royalty on product 3DX under the comparable uncontrolled circumstances. Determining the ALP of this international transaction at Nil, the TPO recommended transfer pricing adjustment of ₹ 164.74 crore. .....

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g to the conclusion that the assessee did not receive any significant benefit from the payment of royalty to its AE because product 3DX was developed in India. Considering that the DRP for earlier years determined ALP of royalty on 3DX model at 0.25% on sales, it gave similar direction for the extant year as well. That is how, the AO vide his final order, reduced the amount of addition to ₹ 156.38 crore, after allowing the benefit of 0.25% as directed by the DRP. The assessee is aggrieved .....

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7 to the financial year 2005 and further that it developed technology for 3DX model through its own R&D division and as such the assessee did not receive any benefit from the so-called use of the technology of 3DX from its AE for which the royalty was paid. He approved, in principle, the application of CUP method by the assesee for the year under consideration in contrast to the TNMM on entity level for earlier years, which was not accepted by him as the most appropriate method. However, on .....

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ibunal vide its combined order dated 18.9.2013 for the assessment years 2006-07 to 2008-09 has not approved the assessee s approach in following the TNMM for benchmarking all its international transactions including Payment of royalty in an aggregated manner. It has been held that the benchmarking should be done on a transaction to transaction basis. In simple words, the Tribunal recommended the following of the CUP method qua the international transaction of payment of royalty. It further found .....

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wards of the paper book. It was fairly admitted before us on behalf of the assessee that the facts and circumstances of the instant year are mutatis mutandis similar to the earlier years. 5. The ld. Sr. AR, however, put forth two fold submissions, viz., first that no addition on account of transfer pricing adjustment is permissible as the AO has not made any disallowance u/s 37(1), and second, the application of the TNMM on entity level should be upheld covering the international transaction of .....

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osed by the ld. DR. 6.2. We are unconvinced with the submission advanced on behalf of the assessee. Their Lordships in the afore referred case have held that the authority of the TPO is limited to conducting transfer pricing analysis for determining the ALP of an international transaction and not to decide if such services exist or benefits did accrue to the assessee. Such later aspects have been held to be falling in the exclusive domain of the AO. In that case, it was observed that the e-mails .....

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owed by AO's assessment order in accordance with law considering the deductibility or otherwise as per section 37(1) of the Act. In our considered opinion, the argument of the ld. AR advocating for the deletion of the addition on the sole ground of the AO not disallowing any amount u/s 37(1) of the Act is sans merit. There is no doubt that the TPO initially determined Nil ALP of the international transaction of Payment of royalty , which was given effect to by the AO in the impugned order, a .....

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the same amount or some part of it by the AO u/s 37(1) of the Act. Rather its converse is true. It is possible that the TPO may find a particular international transaction to be at ALP and the AO, may thereafter make disallowance by considering the applicability of section 37(1). Be that as it may, the Hon ble High Court in this case has remitted the matter back to the authorities below for following the mandate, viz., the TPO firstly determining the ALP of the international transaction and then .....

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mendation of the TPO without carrying out any independent investigation in terms of the deductibility or otherwise of such payment in terms of section 37(1) of the Act. An addition of ₹ 156.38 crore has been made by the AO in his final assessment order giving effect to the direction given by the DRP and not by invoking section 37(1) of the Act. As per the ratio decidendi in Cushman & Wakefield India (P.) Ltd. (supra), the TPO was required to simply determine the ALP of the internationa .....

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amp; Wakefield (supra). Respectfully following the precedent, we set aside the impugned order and remit the matter to the file of AO/TPO for deciding this issue in conformity with the law laid down by the Hon'ble jurisdictional High Court in the case of Cushman & Wakefield (India) (P.) Ltd. (supra) and also the tribunal orders in assessee s own case for immediately preceding five assessment years to the extent they accord with this judgment. 7.1. Next argument of the ld. AR was that the .....

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NMM. Notwithstanding the fact that such a contention has been repelled by the tribunal for earlier years, still the ld. AR canvassed this view before us by relying on the judgment of the Hon ble jurisdictional High Court in Sony Ericsson Mobile Communications India (P) Ltd. VS. CIT (2015) 374 ITR 118 (Del), which in the opinion of the ld. AR, is an authority for the proposition that aggregation of all the international transactions for benchmarking under the TNMM is permissible and, there is no .....

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h Court held, inter alia, that the international transaction of AMP expenses should be bundled/aggregated with other international transaction carried out by the assessee as a distributor, who either simply acts an agent of manufacturer or purchases goods from the manufacturer for resale at his own account. The Hon ble High Court held that where the TNMM has been applied as the most appropriate method by a Distributor, which method has not been disturbed by the TPO, then, the international trans .....

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nsactions at par. If probable comparables are not performing similar functions as done by the assessee and no adjustment is possible for bringing the international transactions of the assessee in an aggregated manner at par with those undertaken by the comparables, then, segregation should be done and the international transaction of AMP should be separately processed under the transfer pricing provisions. In such a determination of ALP of AMP expenses in a segregated manner, proper set off on a .....

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bly in a bundled manner with the distribution activity [Paras 91, 121 & others] ; _ For determining the ALP of these transactions in a bundled manner, suitable comparables having undertaken similar activities of distribution of the products and also incurring of AMP expenses, should be chosen [Paras 194(i), (ii), (viii) & others]; _ If no comparables having performed both the functions in a similar manner are available, then, suitable adjustment should be made to bring international tran .....

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a TP adjustment on account of AMP expenses, a proper set off/purchase price adjustment should be allowed from the other transaction of distribution of the products [Para 93] ; 7.4. Though the judgment in Sony (supra) lays down at length the broader principles for determination of the ALP of AMP expenses in the case of a Distributor , certain principles dealing exclusively with the determination of the ALP of AMP expenses in the case of a Manufacturer have also been laid down. Such discussion has .....

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costs including AMP expenses are independent of cost of imported raw material/finished products having some correlation with overall profit. The example highlights the weakness of the TNM Method. The reasoning would be equally valid, where no AMP or ‗brand building' expenses are incurred. (See paragraph 21.8 to 22.10 of the majority decision). The net profit margins can be affected by variation of operating expenses. Thus, the requirement to select appropriate comparable and adjustment .....

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facturing activities. It would not be appropriate and proper to apply the TNM Method in case the Indian assessed is engaged in manufacturing activities and distribution and marketing of imported and manufactured products, as interconnected transactions. Import of raw material for manufacture would possibly be an independent international transaction viz. marketing and distribution activities or functions. We have earlier used the term plain vanilla distributor'. When we use the words plain v .....

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s. The essence of the above para is that two or more unrelated transactions cannot be aggregated and in case of a Manufacturer , the international transactions concerned with the manufacturing activity cannot be aggregated with the AMP activities as both are separate and distinct. 7.6. Nitty gritty of the above discussion is that aggregation of related transactions is permissible, but there is no rule that all the related and unrelated transactions can be combined and shown at ALP under the TNMM .....

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se purchase of goods and acceptance of services lead to manufacture of final product, it does not follow that they are dependent transactions. 7.7. On going through the facts and ratio of the decisions in Sony Ericsson (supra) and Knorr-Bremse (supra), it is manifest that the contention of the ld. AR for aggregating all the international transactions including Payment of royalty , and then applying TNMM on entity level, cannot be upheld because the international transaction of Payment of royalty .....

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turn down the argument of the ld. AR and approve in principle that the TNMM cannot be applied and the international transaction of payment of royalty in respect of model 3DX has to be benchmarked by applying CUP as the most appropriate method. 8. Now, coming to the determination of ALP of this international transaction under the CUP method, we find that the assessee chose three companies as comparable, which, in our considered opinion, have been rightly rejected by the TPO on several cogent rea .....

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