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2016 (11) TMI 123 - DELHI HIGH COURT

2016 (11) TMI 123 - DELHI HIGH COURT - TMI - Transfer pricing adjustment - bench marking - Whether the Tribunal was right in holding that royalty and technical assistance fee did not form part of a composite transaction and have to be treated as two separate transactions for the purpose of benchmarking and computing arms length price? - Held that:- Undoubtedly the assessee was obliged to make the payment and that obligation arose from the agreements, a pre-incorporation binding contract. However .....

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nceivably be various reasons not to subject such payments, such as for instance, if no similar data exists at all; or that sectional data for such payments is absent. Quite possibly, this may also be a general pattern of expenditure which AEs may insist to part with technology; further, similarly, other models of payment- deferred or lump sum, along with royalty or inclusive of it, may be discerned in comparable transactions. However, to say that such a substantial amount had to necessarily be p .....

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- Transactional Net Margin Method applied for benchmarking/computing arm's length price in respect of transaction relating to "technical assistance fee" - Held that:- This court concurs with the assessee that having accepted the TNMM as the most appropriate, it was not open to the TPO to subject only one element, i.e payment of technical assistance fee, to an entirely different (CUP) method. The adoption of a method as the most appropriate one assures the applicability of one standard or cri .....

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d question is, therefore, answered in favour of the assessee; the TNMM had to be applied by the TPO/AO in respect of the technical fee payment too. - ITA No. 350/2014 - Dated:- 25-10-2016 - MR. S. RAVINDRA BHAT & MS. JUSTICE DEEPA SHARMA JJ. Appellant Through: Sh. Ajay Vohra, Sr. Advocate with Sh. Neeraj Jain and Sh. Aditya Vohra, Advocates. Respondent Through: Sh. P. Roychaudhri, Sr. Standing Counsel with Ms. Vibhooti Malhotra, Jr. Standing Counsel. MR. S. RAVINDRA BHAT 1. The assessee appe .....

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yalty and technical assistance fee did not form part of a composite transaction and have to be treated as two separate transactions for the purpose of benchmarking and computing arms length price? 2. Whether the Income Tax Appellate Tribunal was right in holding that Transactional Net Margin Method should not be applied for benchmarking/computing arm's length price in respect of transaction relating to ''technical assistance fee"? 2. The assessee is a Joint Venture Company (JV) .....

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sessee entered into agreement with its foreign Associated Enterprise (A.E.) for acquiring technology required for the purpose of manufacturing ECUs in respect of the following : - (1) Euro IV/75 HP 1.3 SDE/Suzuki Swift car application (2) Bharat III/75 HP 1.3 SDE/MS Swift application (3) Bharat III/75 HP 1.3 SDE/Tata Indica car application (4) Bharat III/75 HP 1.3 SDE/Fiat India Palio-Linea car application. 3. The assessee applied the Transactional Net Margin Method (TNMM) to benchmark its inter .....

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rs data of Magneti Marelli Powertrain India Pvt. Ltd. The assessee, on the basis of its analysis claimed that its international transactions under the broad head (which included Payment of technical assistance fee') were the Arm s Length Price (ALP). This was rejected by the TPO who held that the Transactional Net Margin Method ( TNMM ) had to be applied separately for each international transaction and not collectively as done by the assessee. He, therefore, held all international transacti .....

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of this transaction was determined. The assessee was unsuccessful before the Dispute Resolution Panel (DRP). In the final order passed under Section 144C(13), the A.O added the amounts towards income. The assessee was aggrieved against such addition and appealed to ITAT. 4. The ITAT firstly held that merely because the assessee capitalized the amount (Rs. 38.58 crores) in the year and claimed depreciation on it, did not take the transaction outside the ambit of international transaction'. T .....

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ctions of import of raw material, sub-assembles and components, payment of technical assistance fees, payment of royalty, payment of software and purchase of fixed assets under one segment of 'Manufacturing of the automotive components' and analyzed all such transactions on a combined basis. This type of combined benchmarking of all the international transactions is not in accordance with law. The mere fact that the overall profit earned by the assessee is more, would not ipso facto lead .....

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n' to show that its international transaction for the current year was at ALP. The requirement under the relevant provisions of the Act along with the rules is to consider the actual' figures and not any projected' figures. It is beyond our comprehension as to how the projected figures can be substituted for the actuals when the requirement is to benchmark actual international transactions at ALP. We, therefore, do not approve the methodology adopted by the assessee in this regard. 8 .....

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rule for use of multiple year data is only an exception and not a rule, which can be invoked if the data for the current year does not result into the determination of correct prices. Nothing of the sort has been shown as to why the data of the comparables for the current year was not appropriate. We, therefore, reject this point of view canvassed by the assessee in making comparability. 9. We further observe that the approach adopted by the TPO is also not correct. He rejected TNMM as applied b .....

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one wrong by considering that the foreign A.E contributed capital to the tune of ₹ 20 crores and odd and took away a sum of ₹ 38 crores and odd in the shape of fees for technical services. This type of comparison made by the TPO for determining that the ALP of the international transaction of payment of technical fee at Nil, has no legal legs to stand on. When he resorted to the application of CUP method, it was incumbent upon him to ask the assessee for the submission of details of .....

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se with that of the assessee. He simply proceeded to adopt nil value of as ALP of the international transaction of payment of technical fee and proposed addition for the full amount. In our considered opinion, when the assessee did receive technical information and earned income by using the same, it cannot be said that it has ALP at nil. Some sort of comparison is inevitable under this method, unless it is shown that the assessee did not get any advantage at all by making payment to its AE. 10. .....

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sh determination of ALP of this international transaction. We order accordingly. The ld. AR has agreed to assist the TPO in providing data of certain comparable cases which could assist in the determination of ALP. In such fresh proceedings, the TPO will ascertain as to which method can be correctly applied and then decide the question before him. Needless to say, a reasonable opportunity of being heard will be given to the assessee. 5. Mr. Ajay Vohra, learned senior counsel urges that under Sec .....

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s contention that under TNMM, various components of payments and expenses could be aggregated together is in error of law. 6. Learned senior counsel relies on Sony Ericsson Mobile Communications India (P) Ltd v Commissioner of Income Tax (2015) 374 ITR 118 (Del), a decision of a Bench of this Court, which reviewed the methodology that TPOs are to adopt while determining ALP. The said judgment held, inter alia, that: The use of the expression "class of transaction", "functions per .....

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legal proceedings. Rule 10A in clause (d) states that "for the purpose of this rule and rules 10AB and 10E", the term "transaction" would "include a number of closely linked transactions". This rule in positive terms declares that the legislative intent is not to deviate from the generic rule that singular includes plural. The meaning or definition of the expression "transaction" in clause (d) of rule 10A read with sub-section (1) of section 92C, therefore .....

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ons. The use of plurality by way of necessity and legislative mandate is evident in the said rule. 81. Similarly, sub-rule (3) of rule 10B refers to transactions being compared or comparison of the enterprises entering into such transactions likely to affect the price or cost charged, etc. A reading of rule 10C reassures and affirms that the general principle of plurality is not abandoned or discarded. ********** ***************** ******* 91. In case the tested party is engaged in single line of .....

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controlled bundled transactions cannot be adequately compared on an aggregate basis. Thus, the taxpayer can aggregate the controlled transactions if the transactions meet the specified common portfolio or package parameters. For complex entities or where one of the entities is not "plain vanilla distributor", it should be applied when necessary and applicable comparables on functional analysis, with or without adjustments are available. Otherwise, the TNM method should not be adopted o .....

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f determining the arm's length consideration for the controlled transactions. There are often situations where separate transactions are intertwined and linked or are continuous that they cannot be evaluated adequately on separate basis. Secondly, the controlled transaction should ordinarily be based on the transaction actually undertaken by the AEs as has been struck by them. We should not be considered as advocating a broad-brush approach but, a detailed scrutinized ascertainment and deter .....

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transaction would be an arbitrary exercise. This legal position stands affirmed in EKL Appliances Ltd. (supra). The decision accepts two exceptions to the said rule. The first being where the economic substance of the transaction differs from its form. In such cases, the tax authorities may disregard the parties' characterisation of the transaction and re-characterise the same in accordance with its substance. The Tribunal has not invoked the said exception, but the second exception, i.e. wh .....

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eir considered opinion, the second exception governs the instant situation as per which, the form and substance of the transaction were the same but the arrangements made in relation to a transaction, when viewed in their totality, differ from those which would have been adopted by an independent enterprise behaving in a commercially rational manner. The aforesaid observations were recorded in the light of the fact in the case of L.G. Electronics (supra). Commenting on the factual matrix of L.G. .....

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ding or the ratio, is indicated or stated. There is no material or justification to hold that no independent party would incur the AMP expenses beyond the bright line AMP expenses. Free market conditions would indicate and suggest that an independent third party would be willing to incur heavy and substantial AMP expenses, if he presumes this is beneficial, and he is adequately compensated. The compensation or the rate of return would depend upon whether it is a case of long-term or short-term a .....

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y disturbed as it would strike at the root of economic viability of the concern. Mr. Vohra here submitted that the purpose of making technical fee payments was to obtain access to technology and services that went to the establishment of the unit. Royalty was a recurring payment, in accordance with the agreement; however technical service charges were not recurring annual payments. Without agreeing to this payout, the assessee would not have been able to secure access to the entire repertoire of .....

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Ms. Vibhuti Malhotra, counsel for the revenue, refuted the assessee s submissions. She urged firstly that Sony Ericsson (supra) does not stipulate any invariable rule with respect to aggregation or desegregation of transactions. Rather, it merely endorsed the view that aggregation is desirable. It was argued that while the commercial decision- making and choices of an entity are to be largely left intact, this court recognized that in ALP determination, it is essential that there are two excepti .....

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; the assessee s explanation that this was necessary, was rejected and it was concluded that the cost- benefit analysis provided did not explain why such a large amount was paid to the AE, when royalty was separately paid. Counsel argued that more importantly, the TPO noticed that large sums of money were paid towards travel expenditure of the AE s personnel, which was not explained. The inadequacy of the assessee s explanation led to the addition. Counsel contended that though the TPO s rejecti .....

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e transaction, i.e. the payment and that this finding does not call for interference. Analysis and Conclusions 11. Sections 92-A to 92-E were introduced into the Income Tax Act, to address a gap, i.e the evaluation of true income, which transnational entities strive to locate within a more friendly tax regime, as opposed to where they are in reality to be subjected to assessment. The Income Tax Rules were also appropriately amended to give effect to this Parliamentary intent. Broadly, the Act an .....

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) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction or a specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) comparable uncontrolled price method, by which,- (i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identifi .....

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or the specified domestic transaction; (b) resale price method, by which,- (i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or si .....

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ble uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market; (v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise; (c) cost plus method, by which,- (i) the direct and indirect costs of production incurred by the enterpris .....

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use (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii); (v) the sum so arrived at is taken .....

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tion, by which- (i) the combined net profit of the associated enterprises arising from the international transaction or the specified domestic transaction in which they are engaged, is determined; (ii) the relative contribution made by each of the associated enterprises to the earning of such combined net profit, is then evaluated on the basis of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which .....

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mbined net profit referred to in sub-clause (i) may, in the first instance, be partially allocated to each enterprise so as to provide it with a basic return appropriate for the type of international transaction or specified domestic transaction in which it is engaged, with reference to market returns achieved for similar types of transactions by independent enterprises, and thereafter, the residual net profit remaining after such allocation may be split amongst the enterprises in proportion to .....

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it margin realised by the enterprise from an international transaction or a specified domestic transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to t .....

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referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction or the specified domestic transaction; (f) any other method as provided in rule 10AB." 12. In short, the relevant provisions, i.e Sections 92, 92-C, 92-D and 92-E read together with Rule 10-B and 10-D indicate the approach .....

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lied. In the judgment of this court, reported as Commissioner of Income Tax v. EKL Appliances Ltd. (2012) 345 ITR 241 (Del), it was held as follows: "It is very imperative on the part of the assessee, to establish before the TPO, that the payments made were commensurate to the volume and quality of services and such costs are comparable. No such efforts was made. No ALP was computed by the assessee. As held by the Assessing Officer, as well as the Commissioner (Appeals), the assessee has no .....

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f different skill, experience, knowledge level, complexity of software projects handled, risk bearing capacity, etc. The entire revenue of the assessee are from the Deloitte. The evidence filed in support of the fact that services are rendered in the form of e-mails show that they are not e-mails relating to marketing, but that they relate only to billing. As rightly pointed out by the learned Departmental Representative, the assessee has no role in interacting with the client to modify, cancel, .....

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sel for the assessee that these three marketing personnel project the capabilities of the assessee company so that Deloitte gets work, is not supported by any evidence and, hence, without basis. In our view, under similar circumstances a uncontrolled comparable company would not incur such expenditure. Hence, the ALP is rightly determined at "nil". As no expenditure would have been incurred, there is no necessity to apply a particular method to arrive at such conclusion. In fact, by al .....

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upra) - while endorsing that view- also stated that whether to permit aggregation or not is a fact dependent decision, driven by the materials in any given case. 14. The assessee/appellant during 2008-09 entered into four License & Technology Assistance Agreements (LTAAs) with its overseas AE for four products for obtaining ECU technology. In return for the technical knowhow, the assessee agreed to compensate the AE through a fee amounting to US $ 2 million for each LTAA (total US$ 8 million .....

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engthened this contention by saying that it earned revenue of ₹ 42.23 crores from the sale of ECUs using the above mentioned technical know-how as a result of payment of ₹ 38.59 crores during FY 2008-09. Further, the assessee also earned aggregate revenue of ₹ 174.89 crores during a period of 3 consecutive years (i.e. FY 2008-09, FY 2009-10 and FY 2010-11) against a total payment of US $ 8,000,000, equivalent to ₹ 38.59 crores paid in FY 2008-09. During the transfer price .....

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undoubtedly not correct. That, however, would not conclude the issue. 15. The assessee s argument that the technology itself would not have been given to it, but for the substantial fee (paid over and above the royalty payable), in the opinion of this court, requires a closer scrutiny. The initial burden is always upon the assessee to prove that the international transaction was at Arm s Length. Its TP report necessarily had to draw a comparison with other entities (maybe competitors) to show th .....

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ry payment that is part of an international transaction is to be conducted irrespective of such obligation undertaken by the parties. If the transactions are, in the opinion of the TPO, not at arm's length, the required adjustment has to be made, as provided in the Act, irrespective of the fact that the expenditure is allowable under other provisions of the Act. There can conceivably be various reasons not to subject such payments, such as for instance, if no similar data exists at all; or t .....

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