TMI Blog2019 (2) TMI 1666X X X X Extracts X X X X X X X X Extracts X X X X ..... entical issue relating to comparability of the price charged to AEs and non AEs situated in different geographical locations. The Tribunal held that in such circumstances CUP cannot be applied as the most appropriate method. Therefore, we hold that CUP method applied by the TPO to determine the arm's length price of the price charged for sale of finished products to the AEs is invalid. Accordingly, accepting assessee s claim we delete the addition made by the AO. Ground raised is allowed. TP adjustment made to the payment of royalty for use of technical knowhow - assessee has benchmarked the transactions adopting TNMM as the most appropriate method and TPO has rejected the benchmarking primarily for the reason that the payment of royalty not being for the purpose of business has to be disallowed u/s 37(1) - HELD THAT:- As decided in own case [ 2018 (9) TMI 1007 - ITAT MUMBAI] when the comparable proposed by the TPO are in different geographical location we do not understand how they can be compared to the assessee. TPO having not determined the arm's length price in conformity with statutory provision and in the process having failed to demonstrate that arm' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ibunal has deleted the addition made on account of transfer pricing adjustment . TPO himself agrees that the AE has provided software and certain services, there is no reason for not accepting the payment made to the AE to be at arm's length in the absence of any contrary evidence brought on record and by simply applying the benefit test. If the TPO did not agree to the arm's length price shown by the assessee it was open for him to determine the arm's length price by applying one of the most appropriate methods being backed by supporting material. Without complying to the statutory provisions, the Transfer Pricing Officer certainly cannot determine the arm's length price on ad hoc / estimation basis Facts relating to the disputed issue being identical in the impugned assessment year, respectfully following the decision of the Co ordinate Bench in assessee s own case, we delete the addition made on account of adjustment to the arm's length price of payment made to the AE towards availing of information system services - ITA No. 7330/Mum/2017 - - - Dated:- 22-2-2019 - SHRI SAKTIJIT DEY, JUDICIAL MEMBER AND SHRI RAJESH KUMAR, ACCOUNTANT MEMBER ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anies as comparables with mean margin of 6.06%. Since, the margin shown by the assessee at 8.00% is more than the mean margin of the comparables, the assessee claimed the international transactions with the AEs to be at arm's length. 4. After going through the material on record, the Transfer Pricing Officer noticed that some common products were sold to both the AEs and non AEs. Therefore, he called upon the assessee to submit the price at which such common products were sold to AEs and non AEs and in case of any difference in price, he called upon the assessee to explain why necessary adjustment should not be made applying Comparable Uncontrolled Price (CUP) method. After furnishing the necessary details, though, the assessee justified its benchmarking of international transactions with the AE in all segments, however, the Transfer Pricing Officer observed that the assessee has sold same products to non AEs at a higher rate than the rate at which it has sold such products to the AEs. The Transfer Pricing Officer observed, since these transactions are not closely linked, they have to be separately benchmarked applying CUP method. Having held so, the Transfer Pricing O ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Referring to rule 10B(2) of I.T. Rules, the learned Authorised Representative submitted, the said rule clearly specifies that comparability of an international transaction relating to the AE with an uncontrolled transaction will have to be made keeping in view the geographical location amongst other things. Thus, he submitted, the Transfer Pricing Officer could not have compared the price charged to non AEs in India with the price charged for transactions with overseas AEs. He submitted, while dealing with identical issue in case of another sister concern viz. Firmenich Aromatics Production (India) Pvt. Ltd. v/s ITO, in ITA no.7145/Mum./ 2017, dated 13th November 2018, the Tribunal has expressed similar view. In this regard, he drew our attention to the relevant observations in the said order. The learned Authorised Representative also relied upon the decision of the Hon'ble Jurisdictional High Court in PCIT v/s Amphenol Interconnect India Pvt. Ltd., [2018] 91 taxmann.com 441 (Bom.). 6. The learned Departmental Representative relying upon the reasoning of the Transfer Pricing Officer and the DRP submitted, since there is a difference in the pricing of transactions of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e price charged to non AEs in India cannot be used as a CUP for determining the arm's length price of the sales of finished products made to overseas AEs. One of the conditions of rule 10B(2) of the I.T. Rules, 1962, is, while considering the issue of comparability with an uncontrolled transaction, the conditions prevailing in the markets in which the respective parties to the transaction operate including the geographical location along with other factors have to be examined. Therefore, geographical location of the party to whom sales were made is a crucial factor to be weighed in while making comparability analysis. Undisputedly, in the facts of the present appeal, the Transfer Pricing Officer has compared the price charged to non AEs located in India with the price charged to AEs in foreign countries. Therefore, the AEs and non AEs being situated in different geographical locations, there may be various factors/reasons which could have influenced the price charged by the assessee to the AEs and non AEs. Hence, the price charged to non AEs cannot be considered to be a CUP to determine the arm's length price of the price charged for sale of finished products to the AEs. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the group‟s requirement results better management of production supply chain and resource management. Lower volume (small orders specific to the requirement of each customers) Geographical difference Export prices of same products are bound to be different in different geographical locations / markets, as these prices are factor of buying power, market sensitivity and local competitions etc. Thus it would not be economically right to compare export prices of different market of locations. 9. According to us, the price at which finished products were sold to AEs are not comparable with prices at which they have been sold to Non-AEs for the below mentioned reasons:- i). Differences in volume of both the transactions - It is general knowledge that volumes commands the prices. Purchase or sale of lower quantities are expensive, this is usually because of cost of transportation for deliveries and administration cost involved in handling smaller deliveries. The assessee is engaged in manufacturing of aromatic ingredients, natural and synthetic perfumery, flavoring and derivative ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Non-AE,one of the example taken from the facts of the case is that w.r.t. product Damascenone Total‟, the assessee had sold 25 kg to a Non-AE at the rate of INR 38,000 per kg and sold 1,260 kg and 16,299 kg at the rate of INR 9,800 and INR 9,664 respectively to its AE namely, Firmenich Aromatics (China) Company Limited and Firmenich SA. Similarly, the assesee has sold 50 kg of the same product at the rate of INR 36,408 to other AE. Thus, TPO erred in comparing small; quantities with large quantities, thereby ignoring the volume difference. We also noted that when the quantity sold to a Non-AE is higher than that sold to an AE, then the price charged from the AE is more than non-AE. The assessee also explained that this would show that the comparison done by the TPO is wholly erroneous. 10. Further according to us, differences in the geographic markets export prices of same products are bound to be different in different geographical locations / markets, as these prices are factor of raw material prices in those respective locations and also because of market sensitivity, bargaining power and local competition. The following table highlights the differences in geog ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e most appropriate method. 12. We find that this issue is covered by the decision of the Co-ordinate Bench of this ITAT in the case of M/s. Amphenol Interconnect India Pvt. Ltd., in ITA No. 477/Pun/2015 [TS-201-ITAT-2014(PUN)-TP], wherein it is held as under: 8. In this regard, the Ld. Counsel for the assessee brought our attention to the DRP's order dated 24-12-2014 and read out the contents of Para Nos. 3.15 to 3.17 which read as under : 3.15 The assessee submitted that the TPO also disregarded and ignored Tribunal rulings which have laid down principles that the transactions will not be considered as similar for the purpose of benchmarking transactions under CUP method merely on account of similar products sold to AEs to third parties. These rulings are as under: Intervet India Private Limited Vs ACIT (ITA No.3185/Mum/2006 ACIT Vs. Dufon Laboratiories (2010-TII-26-ITAT-MUM-TP) Ranbaxy Laboratories Ltd. Vs. Asstt. CIT (208-TII-01-ITAT- DEL-TP) Gharda Chemicals Ltd. Vs. The Deputy Commissioner of Income tax (ITA No.2242/MUM/06) Schutz Dishman Biotech Pvt. Ltd. Vs. DCIT (ITA No.3590 3751/ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of the raw materials. Appropriateness of the TNMM method was also the issue in those years. Tribunal decided the issue in favour of the assessee and dismissed the appeal of the revenue on those issues. After hearing both the ITA No.477/PUN/2015 sides and perusing the contents of the DRP, we are of the opinion that the order passed by the DRP with reference to the most appropriate accounting method for TP study, is fair and reasonable and same does not call for any interference. Accordingly, the ground raised by the Revenue is dismissed . 13. Further, Hon‟ble Bombay High Court dismissed the appeal of the Department filed by the Department against the ITAT‟s order and noted that in this case, since the finished goods are customized goods and the geographical differences, volume differences, timing differences, risk differences and functional differences, the CUP method would not be the most appropriate method to determine the ALP. It upheld the stand of the assessee that TNMM is the most appropriate method to arrive at ALP. This judgement is reported as PCIT Vs. M/s. Amphenol Interconnect India Pvt. Ltd., (supra). 14. In view of the above facts of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... quired to be paid any more because the assessee no more needs the technical knowhow from the AE, (iv) The AE has not collected any royalty for technical knowhow from another subsidiary in India. Thus, on the basis of the aforesaid reasons, the Transfer Pricing Officer ultimately concluded that the assessee having failed to make out a case that the payment of royalty to the AE is for the purpose of business, it has to be disallowed under section 37(1) of the Act. However, observing that the assessee might be getting some technical input to run his manufacturing plant, he ultimately held that 10% of the royalty paid to the AEs can be allowed. Therefore, he proposed an adjustment of ₹ 20,76,49,475, after determining the arm's length price of royalty paid to the A.E. at ₹ 2,30,72,163. Without prejudice to above finding, he observed that the arm's length price of the royalty paid to the AEs can be determined at 1% on net value added sales as per three similar agreements between unrelated parties which, according to the Transfer Pricing Officer, can be used as external CUP. On the basis of transfer pricing adjustment proposed by the Transfer Pricing Officer, the Asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n this ground relates to determination of arm's length price of the royalty paid by the assessee to its AE. As could be seen from the facts on record, the assessee is availing technical knowhow from its AE in Switzerland since past so many years and paying royalty for the services availed. For this purpose, the assessee has entered into a license agreement with the AE from the very inception of carrying out the manufacturing activity of industrial flavours and fragrances, which has been renewed from time to time. The transactions in the impugned assessment year were under a license agreement executed on 1st April 2009. Though, the assessee was required to pay royalty @ 5% on local sales and @ 8% on export sales, net of Indian taxes, however, there is no major change in the terms of the contract, except for the fact that the in the impugned assessment year, the assessee has paid royalty on the gross sales instead of net sales as was done in the preceding assessment years. In the transfer pricing study the assessee has benchmarked the royalty payment by applying TNMM as the most appropriate method and has aggregated it with other international transactions in the manufacturing se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transaction between related parties. Section 92 of the Act provides for computation of income arising from international transaction at arm's length price. Section 92C of the Act provides for determination of arm's length price of an international transaction by applying the most appropriate method having regard to the nature of transaction for class of transaction or functions performed, etc. The most appropriate method prescribed are as under: i) Comparable Uncontrolled Price Method; ii) Resale Price Method; iii) Cost Plus Method; iv) Profit Split Method; v) Transactional Net Margin Method; and vi) Such other methods, as may be prescribed by the Board. 12. Rule 10B of Income Tax Rules, 1962 (for short the Rules ), provides the mechanism for determination of arm's length price under the aforesaid methods prescribed under section 92C of the Act. If the Assessing Officer in course of assessment proceedings finds that the assessee has entered into international transactions with its AE, he may with the previous approval of the authority concerned make a reference to the Transfer Pricing Officer under sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Assessing Officer to its Associated Enterprise being restricted to 1% instead of 2%, as claimed by the respondent assessee. This determination of ALP of technical know how royalty by the TPO was ad hoc and arbitrary as held by the CIT(A) and the Tribunal. 13. The Tribunal, Hyderabad Bench in R.A.K. Ceramics India Pvt. Ltd. (supra) while dealing with identical nature of dispute relating to determination of arm's length price of royalty payment by estimation held as under: 7. We have considered the submissions made by learned counsels from both the sides and perused the orders of departmental authorities as well as other materials on record. We have also carefully examined the decisions placed before us. At the outset, it needs to be mentioned, the only dispute arising for consideration before us is determination of ALP of royalty at 2% by TPO as against 3% claimed by assessee. Undisputedly, assessee on 01/04/2009 has entered into a royalty agreement with its AE, RAK, UAE. As per clause 1.1 of the agreement, RAK, UAE will provide the technology assistance and on-going process, product improvement and complete know-how assistance to assessee. Clause 2.1 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... angible transaction should not have been aggregated with tangible transactions. As far as, assessee's analysis under CUP method is concerned, TPO has rejected it citing following reasons: i) it is an alternate analysis ii) database used is for US based companies iii) copies of agreements not furnished; and iv) bench marking has to be done for Indian companies in similar trade making royalty payment. 9. Further, it is evident from TP order, though, TPO has not brought any material to controvert assessee's claim of receiving pecuniary benefit from the technical know-how provided by AE, in terms of sizeable sales, garnering of creditable market share, minimal product recalls, low after sales maintenance cost etc. but he tried to overcome it by observing that such increase in sale is as a result of increase in advertisement marketing expenses and also on payment of commission and discount. TP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... thod. On the contrary, observations made by TPO gives ample scope to conclude that adoption of royalty at 2% is neither on the basis of any approved method nor any reasonable basis. Rather it is on adhoc or estimate basis, hence, not in accordance with statutory provisions. The approach of TPO in estimating royalty at 2% by applying the benefit test, in our view, is not only in complete violation of TP provisions but against the settled principles of law. ITAT, Mumbai Bench in case of Castrol India Ltd. (supra) while examining identical issue of determination of ALP at 'Nil' by applying the benefit test held as under: 11. We have considered the rival submissions and perused the relevant material on record. It is observed that the impugned royalty was paid by the assessee company to its AE namely Castrol Ltd. UK at 3.5 % of the net exfactory sale price of products manufactured and sold in India as per the technical collaboration agreement. This internatio nal transaction involving payment of royalty to its AE was bench-marked by the assessee by following CUP method in its TP study report and since average rate of royalty of three comparables selected by it was hig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... relied upon by ld. AR. At the cost of repetition, it needs reiteration, assessee has benchmarked the royalty payment by bringing comparables both under TNMM as well as CUP. Whereas, TPO has rejected the analysis done by assessee under both the methods without any reasonable basis nor has brought a single comparable to justify ALP of royalty at 2%. Unfortunately, ld. DRP has approached the entire issue in rather mechanical manner without examining whether approach of the TPO is in accordance with statutory mandate. Therefore, determination of ALP of royalty at 2% cannot be supported, hence, deserves to be struck down. Moreover, theory of benefit test applied by TPO also falls flat considering the fact that TPO does not question the necessity of paying royalty but only objects to the quantum. Further, quantum increase in sale with no apparent increase in production, minimal product recalls, low after sales maintenance cost certainly goes to prove assessee's claim that these could be achieved due to utilization of advanced technical know-how transferred by AE. The TPO has not been able disprove these facts with any sound argument. Considering the totality of facts and circumstance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incurred by the assessee in the character of a tender or that it was not laid out exclusively for the purpose of the business so as to disallow it but it is not the function of the revenue to determine what remuneration should be paid to an employee by the assessee. Applying the same logic to the case on hand, once it is admitted by the Revenue that the assessee entered into a royalty agreement with the A.E. and the assessee claimed benefit from such agreement, in the form of quantum increase in sales with no apparent increase in production, minimal product recalls and low after sales maintenance cost, and consequently paid royalty in terms thereof, it was not for the TPO to determine as to what would be the other reasons for increase in the assessee‟s sales and profit. Above all, there is no explanation forthcoming as to why the TPO decided upon 2% instead of the contractual rate of 3% for payment of royalty. No reason is offered by the TPO for picking on 2%. This whimsical fixation by the TPO amounts to an arbitrary and unbridled exercise of power. In consequence, we find that the TPO having rejected the comparables cited by the assessee, did not take th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ative benchmarking suggested by the Transfer Pricing Officer. As could be seen from the order passed by the Transfer Pricing Officer, referring to three agreements / comparables stated to have been selected by him on search of a particular data base, he found that the arm's length price of the royalty payment to the AE should be @ 1% of the net sales. However, the fact on record reveal that during the transfer pricing proceedings, in response to a show cause notice issued by the Transfer Pricing Officer, the assessee has specifically objected to the comparables proposed by the Transfer Pricing Officer by stating that none of the comparable are functionally similar to the assessee since all of them related to asset purchase agreement and further all the parties relating to such agreement are located outside India, hence, are not governed by Indian rules and regulations. The aforesaid objection of the assessee has neither been dealt with nor controverted by the Transfer Pricing Officer. Thus, when the comparable proposed by the Transfer Pricing Officer are in different geographical location we do not understand how they can be compared to the assessee. It is further necessary to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s the average of 46 companies in Bloomberg Database. In reply, the assessee objected to the proposed adjustment by the Transfer Pricing Officer. However, the Transfer Pricing Officer did not find merit in the submissions of the assessee and ultimately determined the arm's length price of the interest paid to the AE on ECB loan at LIBOR plus 143.62 basis points which resulted in an adjustment of ₹ 30,53,362. 18. The learned Authorised Representative, at the outset submitted, the assessee has raised two additional grounds challenging the aforesaid transfer pricing adjustment. In this context, he drew our attention to the said additional grounds which are as under: 3.3 On the facts and in the circumstances of the case and in law, the Hon‟ble Dispute Resolution Panel has erred in upholding the action of the Transfer Pricing Officer in making adjustment to the entire amount of interest on External Commercial Borrowings ( ECB ) in A.Y. 2013 14 only without appreciating the fact that the entire interest amount has been debited to Capital Work in Progress Account and is neither debited to the Profit Loss Account nor claimed as deduction by the Appell ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e submitted, the method adopted by the Transfer Pricing Officer for benchmarking the arm's length price of interest paid on ECB loan being a better method, the adjustment made is valid. 23. We have considered rival submissions and perused material on record. At the outset, we must address the issue relating to the admission of additional grounds raised by the assessee. In this context, we must observe, the issues raised in the additional grounds were never raised by the assessee at any stage and have only been raised in course of appeal hearing before us. The assessee has not even claimed depreciation in the return of income which is the issue raised in the additional ground no.3.4. The principle of law on the issue of admission of additional ground is very much clear. If the additional grounds require examination of fresh facts which have not been examined at any stage, the additional grounds cannot be allowed. After examining the factual and legal position relating to the admission of additional grounds, we are of the view that taking a decision on the additional grounds raised by the assessee requires examination / verification of fresh facts relating to utilization ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as to be determined at six months USD LIBOR rate plus 300 basis points. The Assessing Officer is directed to carry out the adjustment accordingly. This ground is partly allowed. 25. In ground no.4, the assessee has challenged the addition made on account of transfer pricing adjustment in relation to availing of information systems (IS) services. 26. Brief facts are, in the course of proceedings before him, the Transfer Pricing Officer wanted to determine the arm's length price of the payment of ₹ 14,26,34,846, to the AE towards charges for usage of software during the year. He, therefore, called upon the assessee to submit documentary evidences for use of software, actual services provided by the AE, basis for allocation of cost to the assessee, cost incurred by the AE and evidence for third party payment by the AE. Further, the Transfer Pricing Officer called upon the assessee to explain why the arm's length price of software charges should not be taken as nil in case the assessee fails to substantiate that the services were availed by it. Though, in replies dated 8th September 2016 and 20th September 2016, the assessee apart from furnishing documen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the adjustment made by the Transfer Pricing Officer is not by following anyone of the most appropriate methods prescribed under the statute but on an ad hoc or estimate basis. In fact, learned DRP has upheld the adjustment made by the Transfer Pricing Officer simply relying upon their decision in assessment year 2012 13. While doing so, the DRP has even observed that the facts in the impugned assessment year are similar to those prevailing in assessment year 2012 13. Notably, while deciding identical issue in assessee s own case in assessment year 2012 13, in the decision referred to above, the Tribunal has deleted the addition made on account of transfer pricing adjustment with the following observations: 21. We have considered rival submissions and perused materials on record in the light of decisions relied upon. Though, the Transfer Pricing Officer has alleged that the assessee failed to furnish any evidence to substantiate its claim that the payment made to the AE for availing Information System Services, however, the material on record reveal that the assessee has not only undertaken a bench marking process for determining the arm's length price of the transac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lication of the relevant statutory provisions. As regards the observations of the DRP regarding the report of the KPMG, it is necessary to observe that the KPMG report is not an audit report but was furnished by the assessee to support the attribution of cost. Therefore, it cannot be said that it is a qualified report. It is further relevant to observe, the material submitted before us, which also forms part of the Transfer Pricing Officer‟s record, indicates that the cost of the software has been allocated to 40 group companies across the globe who are using the software and related services and assessee‟s share in cost allocation works out to 2.3%. Moreover, when the Transfer Pricing Officer himself agrees that the AE has provided software and certain services, there is no reason for not accepting the payment made to the AE to be at arm's length in the absence of any contrary evidence brought on record and by simply applying the benefit test. If the Transfer Pricing Officer did not agree to the arm's length price shown by the assessee it was open for him to determine the arm's length price by applying one of the most appropriate methods being backed by sup ..... X X X X Extracts X X X X X X X X Extracts X X X X
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