TMI Blog2019 (10) TMI 296X X X X Extracts X X X X X X X X Extracts X X X X ..... prescribed methods. Thus, the order of the TPO is defective in not following the methods prescribed under the Act. Commercial expediency is the business decision of the tax payer and the AO cannot sit and judge the business expediency as decided by the Hon'ble Delhi High Court. The coordinate bench of ITAT, Delhi also held that TNMM is the most appropriate method for benchmarking the royalty payment. On application of TNMM as MAM at the entity level the PLI of the assessee more than the comparable cases, thus the transactions of the assessee company are at Arm s length. Following the judicial precedents discussed in the preceding paragraphs, we hold that determination of royalty at Rs. NIL is unjustified and the most appropriate method for determining the royalty payment is TNMM method at the entity level aggregating all the transactions including the payment for royalty. Accordingly, we hold that the adjustment made by the TPO is not warranted and the addition made by the Assessing Officer is deleted and the order of the ld. CIT(A) is upheld. For A.Y. 2007-08, the facts are identical and having held that TNMM is the most appropriate method, no adjustment is called for on ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ternational transactions for the purpose of determining the ALP. 5. Royalty has been pad under a separate agreement and therefore has no relation with the other transactions of the assessee with its AE. 6. Payment of royalty and the other transactions with the AE are not closely related transactions but are separate and independent international transaction and therefore these cannot be treated as closely linked transaction for the purpose of transfer pricing adjustment. 7. The Ld. CIT(A) ought to have noticed that the profit margins shown by the assessee is low compared to comparable cases which justifies disallowance of Royalty. 3. During the appeal hearing, ld.DR submitted that ground Nos. 1 to 3 are related to the benefit test made by the Transfer Pricing Officer (TPO) for allowing royalty payment. Ground Nos.4 to 7 are related to determination of arm s length price (ALP) in respect of payment of royalty to the Associated Enterprises (AEs). 4. Brief facts of the case are that the assessee SNF India Private Ltd., is a 100% subsidiary of SPCM SA, France has set up its manufacturing unit i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Operating costs : 41.68 Operating profit : 7.2 OP/OR : 14.76% OP/OC : 17.32% 4.3 The tax payer has conducted the transfer pricing study and searched for the comparables by using Prowess data base in search of comparables applying various key words and after applying certain filters, the tax payer has short-listed around 10 comparables, whose arithmetic mean PLI (OP/Sales) was computed at 11.8% as against the margin of taxpayer of 14.76% and accordingly, the taxpayer held that the transactions are at Arm s Length Price and no adjustment was made. The taxpayer adopted TNMM (Transaction Net Margin Method) as most appropriate Method (MAM) at the entity level. 5. The Ld.TPO segregated the royalty payment and worked out the operating margin (OP/OR) of purchases and sales at 18.34% after excluding the Royalty payment and no adjustment was proposed on purchases and sales. The TPO also viewed that T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... part of the order, the PLI (OP/Sale) of the taxpayer for the year under consideration is at 8.57% as compared to the arithmetic mean of the two comparables selected by the top at 10.45% is significantly lower. Therefore, the taxpayer could not demonstrate the tangible benefits that are derived from the so called purchase of technology from its AE. The uniqueness and usefulness of the so called technology is not demonstrated by the taxpayer. It is a well known fact that the technology becomes obsolete and redundant over a period of time. Therefore, the value of the technology gets eroded as the time lapses. The taxpayer cannot pay royalty indefinitely for the technology which is already gets absorbed over a period of time. In an arms length situation, no independent party pays royalty perpetually without deriving any additional benefits. 5.1 In this case, for the A.Y. 2008-09 the taxpayer has made the royalty payment of ₹ 1.75 crores to the AEs @5% on domestic sales and 8% on external sales. Since the TPO has determined the ALP at Rs.NIL, the Assessing Officer has completed the assessment u/sec. 143(3) r.w.s. 92CA(3) by making the additio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmation passed on to improve the process or the quality of the product. It is also seen that the sales revenue and profitability of the Company has increased over the years. Considering these material evidence on record, the assessee's plea that it had received technical information from its AE and has benefits from such technical information provided by the AE remain substantiated. I find that the TPO without considering the e-mail correspondence has taken the view that the technical services provided in the agreement are general in nature, probably as the thrust of argument before the TPO was that as the royalty payment was approved by RBI, it would meet the requirements of ALP. 7. The ld. CIT(A) further held that it is mandatory to benchmark the international transactions as per the relevant TP provisions and the RBI approval for payment of Royalty would not be the criteria. The provisions of section 92C r.w.r. 10B are clear that the ALP in relation to international transactions shall be determined as per the methods prescribed in the Act and the approval of RBI given for remittance of impugned amount to the AE would not in any way fall ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e data for the impugned two assessment years to benchmark the payment of royalty transaction under the CUP method, viewed that CUP method is not most appropriate method and owing to the facts and the circumstances TNMM is most appropriate method in the A.Y. 2007-08 2008-09. The assessee adopted TNMM method at entity level aggregating all the international transactions with OP/OR as the PLI. For the A.Y. 2007-08, the assessee has computed its PLI at 9.9% and has selected 13 comparables and whose average mean of OP/OR was given at 6.42% and claimed that all its international transactions were at ALP. The TPO has selected two comparables taking into account, the current year data and applying appropriate filters, and the average mean of OP/Sales was worked out 10.45%. The TPO also computed the assessee s OP/Sales at 8.57%. The ld.CIT(A) held that the Assessing Officer/TPO may examine whether the assessee s claim that its PLI falls within the range of (+/-) 5% and accordingly determine whether the ALP requirements are met. If the assessee s PLI as determined by the TPO does not fall within the (+/-) 5% range, the ld. CIT(A) directed the Assessing Officer to make prop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nchmarking the international transaction and cannot be linked with other transactions for the purpose of transfer pricing adjustment. The profit margin shown by the assessee is low comparable to the comparable cases. Thus, argued that the Assessing Officer rightly dealt with the royalty payment as a separate transaction and determined the transfer pricing independently. Since the assessee did not receive the benefit for the intangibles or royalties, the ld.DR supported the order of the TPO/AO and requested to set aside the order of the ld. CIT(A) and allow the appeal of the revenue. 12. On the other hand, ld.AR argued that the TPO has determined the ALP of Royalty payment at Rs.NIL against the payment of ₹ 1.75 crores by the assessee which is unjustified and against the transfer pricing scheme and methods specified in Rule 10B of I.T Rules for determining the ALP. The Ld.A.R further submitted that the assessee had entered into an agreement for payment of Royalty with SPCM SA, France for using technology and getting technical information continuously and consistently. As per the agreement, the assessee shall make royalty @5% on domestic sales ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decided by number of High Courts and Tribunals. The ld.AR relied on the decision of the Hon'ble Telangana and Andhra Pradesh High Court in the case of DCIT Vs. R.A.K. Ceramics India Pvt. Ltd. in I.T.T.A.No. 595/2016, dated 23/12/2016. Similarly, ld.AR also relied on the decision of the Hon'ble Bombay High Court in the case of CIT Vs. M/s. Johnson Johnson Ltd., in ITA No.1030/2014, dated 07/03/2017 and the decision of the Hon'ble Delhi High Court in the case of Pr.CIT-3 Vs. Frigoglass India Pvt. Ltd., in ITA No. 123/2017, dated 03/03/2017 and argued that once the assessee is having the agreement for payment of royalty, the TPO cannot sit on the judgment for determination of ALP in the case of royalty. Similarly, by placing reliance on the decision of the Hon'ble Bombay High Court in the case of M/s. Johnson Johnson Ltd., (supra) argued that the disallowance of payment on the basis of assumption that it is excessive, is an action completely dehors the provisions of transfer pricing adjustment. By placing reliance on the judgment of the Hon'ble Delhi High Court in the case of Frigoglass India Pvt. Ltd. (supra), ld.AR argued that the payment of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ime. Hence, determined the ALP of the royalty payment at Rs. NIL for the transfer pricing analysis. For the A.Y. 2008-09, against the payment of ₹ 1.75 crores taking the same analysis, the TPO has determined the ALP of royalty at Rs. NIL. Accordingly, the Assessing Officer made the transfer pricing adjustments as suggested by the TPO and passed the assessment order. 14.1 On appeal ld. CIT(A) admitted the additional evidence and examined the correspondence and e-mails and held that the assessee has substantiated the benefits derived from technical information provided by the AE. The ld.AR argued that use of technical information is interlinked and interrelated with the manufacturing activity of the assessee, therefore, submitted that that the payment of royalty is a mandatory requirement to the assessee for carrying on manufacturing activity of the assessee company. The ld. CIT(A) has completely analysed the issue after giving opportunity to the TPO/Assessing Officer and held that the assessee got technical support from the AE in the manufacturing process and in manufacture of its products. Some of the suggestions given by the AE towards impro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... MAM for determining the ALP of royalty, TPO did not bring any comparable cases. Therefore adopting the CUP method without the support of any comparable cases would be defective. 15. During the appeal hearing, the ld.AR argued that the payment of royalty is interlinked with the manufacturing activity and other trading transitions, therefore, the TNMM is most appropriate method at the entity level and it is necessary to aggregate the entire transactions without delinking with the royalty payments. The Department could not establish that the royalty is independent and separate transaction for unbundling the royalty from the other transactions to determine the ALP independently. Once it is accepted that the technical support is required for manufacturing the product and it is interrelated the payment of royalty cannot be segregated and the transactions required to be aggregated at the entity level and the ALP required to be determined on the whole transactions. Though the TPO held that the CUP is most appropriate method for determining the transfer pricing of the royalty but did not bring any comparables for determination of the royalty payment. Merel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ein the ITAT held that the payments of royalty can be benchmarked and TNMM is the most appropriate method and the commercial expediency for payment of such royalty cannot be questioned. The decision of the ITAT is upheld by the Hon'ble Delhi High Court and the Department filed SLP before the Hon'ble Supreme Court and the Hon'ble Supreme Court dismissed the SLP. For the sake of convenience, we extract the relevant part of the order of the Tribunal as under:- 16. We have heard the rival parties at length and carefully perused the material on record. As far as the issue of royalty is concerned, we find that the assessee had filed in the course of the TPO assessment as well as before the DRP, detailed submissions, including agreement between AE and the assessee, justifying how the technical know-how supplied by its AE was crucial to the running of its business. In CIT vs EKL Appliances 341 ITR 241 (Del), the Hon 'ble Delhi High Court had the occasion to consider an issue of disallowance of royalty by TPO because the assessee in that case had been suffering losses, the Hon'ble High Court while holding that so long as the expenditure or payment by a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ective in not following the methods prescribed under the Act. Commercial expediency is the business decision of the tax payer and the AO cannot sit and judge the business expediency as decided by the Hon'ble Delhi High Court. The coordinate bench of ITAT, Delhi also held that TNMM is the most appropriate method for benchmarking the royalty payment. On application of TNMM as MAM at the entity level the PLI of the assessee more than the comparable cases, thus the transactions of the assessee company are at Arm s length. Following the judicial precedents discussed in the preceding paragraphs, we hold that determination of royalty at Rs. NIL is unjustified and the most appropriate method for determining the royalty payment is TNMM method at the entity level aggregating all the transactions including the payment for royalty. Accordingly, we hold that the adjustment made by the TPO is not warranted and the addition made by the Assessing Officer is deleted and the order of the ld. CIT(A) is upheld. 19. For A.Y. 2007-08, the facts are identical and having held that TNMM is the most appropriate method, no adjustment is called for on account of transfer pricing issues. I ..... X X X X Extracts X X X X X X X X Extracts X X X X
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