TMI Blog2022 (12) TMI 244X X X X Extracts X X X X X X X X Extracts X X X X ..... may be true that the assessee aggregated payment of royalty with the transaction of manufacturing as it was closely linked and adopted transactional net marginal method but that does not mean that the transactions are so interrelated that they cannot be evaluated separately for applying profit split method. Further, the assessee does not make any unique contribution to the transaction, hence profit split method in this case cannot be applied. Therefore, we are of the view that transactional net marginal method is the most appropriate method in the case of the assessee.The Tribunal has upheld transactional net marginal method as most appropriate method from the assessment years 2007-08 to 2011-12. In those assessment years the dispute was whether transactional net marginal method or comparable uncontrolled price was the most appropriate method. It is for the first time in the assessment year 2013-14 that the Revenue has sought to apply profit split method as most appropriate method. In the given facts and circumstances, we are of the view that transactional net marginal method is the most appropriate method and the learned Assessing Officer is directed to apply the said method i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... learned Assessing Officer is directed verify the same and to grant credit for the advance tax paid by the assessee. - I.T. (TP) A. No. 362/Bang/2021 - - - Dated:- 18-7-2022 - N. V. Vasudevan (Vice-President) And Laxmi Prasad Sahu (Accountant Member) For the Assessee : Ms. Hirali Desai , authorised representative For the Department : Pradeep Kumar , Commissioner of Income-tax, Departmental representative ORDER LAXMI PRASAD SAHU (ACCOUNTANT MEMBER). - 1. This appeal filed by the assessee is directed against the assessment order passed by the National e-Assessment Centre, Delhi dated April 22, 2021 for the assessment year 2016-17 with the following grounds of appeal : General 1. That on facts and in the circumstances of the case and in law, the order passed by the learned Assessing Officer, pursuant to the directions of the hon'ble Dispute Resolution Panel-2, Bangalore ('Panel' or 'DRP'), and the order of the learned Deputy Commissioner of Income-tax, Transfer Pricing-Circle (2)(2)(2), Bengaluru ('Learned TPO') to the extent prejudicial to the appellant, is bad in law and facts and liable to be quashed. Transfer pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arable companies is compared with the ratio of operating profit earned by the appellant before royalty to its operating revenue to determine additional profit earned by the appellant ; (b) considering royalty income of comparable companies instead of royalty expenses to compute the royalty/sales ratio ; (c) applying arbitrary methodology of profit allocation between the associated enterprises and the appellant in a 2 : 3 ratio. 9. Without prejudice, the learned Transfer Pricing Officer/hon'ble Dispute Resolution Panel while undertaking the comparability analysis for applying profit split method erred in, (a) considering loss incurred on account of foreign exchange fluctuations as operating in nature while computing the ratio of operating profit earned (before royalty) by the appellant to its operating revenue ; (b) rejecting functionally similar comparable companies selected by the appellant, without providing any reason for rejection of such comparable companies ; (c) randomly selecting certain companies which are functionally dissimilar i. e., Minda Industries Limited, JBM Auto Limited, ZF Steering Gear (India) Limited ; (d) selecting companies which have ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Panel erred in not appreciating that the remittances made are in the nature of cost-to-cost reimbursements, without any profit element and that such reimbursements cannot be considered as income chargeable to tax in the hands of the recipients for the purpose of the provisions of section 195 of the Act. (Tax effect : Rs. 1,86,22,549) 16. That the learned Assessing Officer/hon'ble Dispute Resolution Panel erred in law and on facts in holding expenses (aggregating to Rs. 90,58,664) incurred on account of plant layout charges to facilitate material movement, rearrangement of production lines and for optimum utilization of space to be of capital in nature in the hands of the appellant, even in the absence of any enduring benefit or increase in production capacity. 17. That the learned Assessing Officer/hon'ble Dispute Resolution Panel have erred in stating that the expenses spent on plant layout charges are for setting up or realigning the production process and hence are considered as capital in nature. 18. Without prejudice to the above, the learned Assessing Officer/ hon'ble Dispute Resolution Panel erred in not allowing the consequential additional depreciat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TNMM Income from services 3,27,52,776 TNMM Reimbursement of salary cost of expatriate employee including directors paid 5,37,34,662 TNMM Reimbursement of expenses paid 33,349 21,64,056 TNMM 2. 2.1 The Transfer Pricing Officer passed order on October 30, 2019 by making adjustment under section 92CA of the Act of Rs. 7,52,74,460. By observing as under : 5 Transfer pricing study of the taxpayer 1. In its transfer pricing study, the taxpayer has aggregated all international transactions and has used transactional net marginal method as the most appropriate method to benchmark the international transactions. The Transfer Pricing Officer found that the sale and purchase transactions with the associated enterprises are mini mal. Major transactions are payment of management fees and royalty. The taxpayer has a turnover of Rs. 464 crores and it has used an entity level margin as profit level indicator to benchmark international transaction of small value ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... present taxpayer has been in operation for much more than that. Then why is it paying a running royalty on sales ? Because it consistently gets new technology from its licensor (the associated enterprises). We do not know whether these new technologies are generic or proprietary, whether these new technological updates are unique or easily available in the market. There is no evidence that such tech actually increases the profitability of the company beyond the profits it would routinely get transactional net marginal method cannot give us that benchmark-of relative enhancement of profits from the 'technological updates'. On the contrary, transactional net marginal method can become a method to justify profit shifting in such scenarios. How transactional net marginal method can be misused to justify profit shifting ? 5.5 Consider an automobile company that purchased technologies and machinery for a new vehicle gear system back in 2003. It has no international transaction. It makes better profits than market average. Market average (what we call mean operating profit/operating revenue) is the average of companies performing better than average and worse than average. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e are three basic factors to check : 1 Whether the technology in comparable transaction is similar to the technology of tested transaction ? 2 Are the two technologies (tested transaction and comparable transaction) of similar uniqueness ? 3. Do both technologies have similar utility for enhancing profits? It is usually difficult to find similar transactions where above data is available. If technologies are in similar fields, then we can refer to a technical consultant to make a technology audit and find out if the technologies have similar uniqueness and similar degree of utility, leading to higher profitability. Comparable uncontrolled transactions fails severely if such analysis is not done. Technology transfer is trans fer of intangibles. Without doing a valuation of intangibles involved in the transaction, how do you compare them ? It is like comparing an apple to a black box. There may be an apple inside the black box, or a potato, or even a chicken leg piece. The taxpayer manufactures car seats and other car interiors. It receives technologies from associated enterprises for enhancement of such products. 6. Profit split method as most appropriate method. 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... based on FAR analysis of both. 6.4 Determination of routine return : The entire exercise of finding comparables is to find the routine return of the taxpayer This is the first step. The method of finding routine returns is very similar to transactional net marginal method : just that the mean operating profit/operating revenue of comparables is taken as routine profitability. For this, the Transfer Pricing Officer has to select companies that do not have research and development expenses in the profit and loss. Every manufacturing company generates intangibles/technologies on a daily basis. Such technology is part of the basic and generic technology. But some companies have a separate research and development unit and allocate expenses to the research and development unit. The developments, in the research and development unit are significant intangibles, and lead to additional profitability. Owing to this, companies having research and development expenses in the profit and loss account cannot be taken as comparable. For 'routine returns' we need to take companies that do not have a separate research and development centre and that do not allocate separate expenses to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or uses the asset primarily, but also transfers it to non-competing licensees in other geographies. 6.7.3 Risks : 1. Takes all research risk. 6.8 The FAR analysis of the taxpayer is as under : 6.8.1 Functions : 1 Manufacturing and sales (these functions and returns from same are covered in routine market profits and hence do not carry weight. 6.8.2 Assets 1. None 6.8.3 Risks 1. Complete enterpreneurial risk 2. Risk of competitors getting hold of better technologies 6. 9 Concluding from the above analysis, a weightage of one is given to functions and assets, and one to risks of licensor, and a weightage of three is given to the risks of the licensee. Thereby the profit split has to be in the ratio of 2:3 where licensor gets 2/5 of the residual profits as royalty. 6.10 The calculation of adjustment is as under : Description Amount (INR) Residual profits on revenue 3.15% Arm s length royalty rate A 1.26 Operating revenue B 4,61,23,47,934 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e had made payment of Rs. 5,38,09,953 as reimbursement of salary to expatirates in this regard the assessee made submissions vide letter dated November 18, 2019 provided the details of expat's. Salary reimbursement amounting to Rs. 5,38,09,953 paid during the assessment year 2016-17 and the asses see further submitted that the TDS has been deducted as per section 192 of the Act on the entire salary paid including the salary paid in Japan. The reimbursement of salary portion paid to Toytoto Boshku Corporation (TBJ) is pure reimbursement in nature, as the amount is exactly equal to amount paid by TBJ to expat's at Japan, without any value addition by TBJ and the assessee also submitted that the amount paid is not covered under section 9(1)(ii), hence section 195 is not applicable. After examining the details submitted by the assessee and agreements made in this regard he observed that the TDS is to be deducted on the source based. He also relied on some judgments quoted in his order observed that the assessee has failed to deduct TDS as per section 195 of the Act. Accordingly, he disallowed under section 40(a)(i) of the Act on the entire sum paid and added into the total inco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 1646/Bang/2017 vide order dated April 13, 2022 for the assessment year 2013-14 and also for the assessment year 2015-16. The para Nos. 11.1 to 11.5 in para No. 12 in the assessment year 2013-14 is reproduced here under : 11.1. On the contrary, the learned Commissioner of Income-tax, Departmental representative placed reliance and orders passed by the authorities below. 11.2. We have perused submissions advanced by both sides in light of records placed before us. We note that the functions performed by the assessee before us, and that of Toyota Kirloskar (supra) considered by the co-ordinate Bench of this Tribunal, being the sister concern, are identical in nature. Both these assessee are engaged in manufacture of automotive components, peculiar to automobile industry. The assessee before us aggregated all the international transaction by using transactional net marginal method as the most appropriate method to benchmark the international transactions. The learned Transfer Pricing Officer segregated management fees and royalty payment, which constituted major part of the transaction. The entire dispute before us, is in respect of the method used for benchmarking the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... echnology had an impact on the most appropriate method and that technology in question was to be used by start-ups and since the assessee was using the technology for a fairly long period of more than 5 years, it would not be proper to adopt the transactional net marginal method as the most appropriate method, as the economic life of the technology would no longer exist. In our view, there is no basis for the Transfer Pricing Officer as well as the Dispute Resolution Panel to come to a conclusion that technology in question was to be used by a start-up. There is no basis for the Transfer Pricing Officer and the Dispute Resolution Panel to come to a conclusion that the assessee is a start-up in manufacture of various parts for automobiles. The technology in question was that of TMC Japan. The technology is being used by the assessee even today. There is no basis for the Transfer Pricing Officer/Dispute Resolution Panel's conclusion that the useful economic life of the technology would be only 5 years. In any event passage of time cannot be the basis to discard transactional net marginal method which is already held by the Tribunal and upheld by the hon'ble High Court as no l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... umstances), as in such cases a transactional profit split method typically would not be appropriate in view of the functional analysis of that party.' 16. The revised guidance (June 2018) on the application of trans actional profit split method, provided by the OECD state the importance of delineating the transactions in determining whether the profit split method is applicable or not. The relevant extract from the OECD Guidelines is provided below : '2.125. The accurate delineation of the actual transaction will be important in determining whether a transactional profit split is potentially applicable. This process should have regard to the commercial and financial relations between the associated enterprises, including an analysis of what each party to the transaction does, and the context in which the controlled transactions take place. That is, the accurate delineation of a transaction requires a two-sided analysis (or a multi-sided analysis of the contributions of more than two associated enterprises, where necessary) irrespective of which transfer pricing method is ultimately found to be the most appropriate. 2.126. The existence of unique and valuable contri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e associated enterprises and does not contribute any unique intangibles to the transaction. It may be true that the assessee aggregated payment of royalty with the transaction of manufacturing as it was closely linked and adopted transactional net marginal method but that does not mean that the transactions are so interrelated that they cannot be evaluated separately for applying profit split method. Further, the assessee does not make any unique contribution to the transaction, hence profit split method in this case cannot be applied. 18. Therefore, we are of the view that transactional net marginal method is the most appropriate method in the case of the assessee. The decision of the Tribunal in the earlier assessment year 2008-09 has also been upheld by the hon'ble High Court of Karnataka in CIT v. Toyota Kirloskar Auto Parts (P.) Ltd. (I. T. Appeal No. 104 of 2015, dated July 16, 2018), which was an appeal of the Revenue against the order of Tribunal for the assessment year 2008-09. The Tribunal has upheld transactional net marginal method as most appropriate method from the assessment years 2007-08 to 2011-12. In those assessment years the dispute was whether transactio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Ltd. v. Dy. CIT (I. T. (TP) A. No. 1646/Bang/2017 vide order dated April 13, 2022) for the assessment year 2013-14 and also for the assessment year 2015-16. The para Nos. 14.1 to 14.26 and para No. 15 in the assessment year 2013-14 is reproduced here under : 14.1. At the outset it would be useful to understand the concept of assignment or secondment. Multi-national companies with a view to utilize skill within the group companies has global mobility policy of assignment or secondment. Secondment is, deputing or sending one employee in one entity of the multi-national company in one country, to another entity of the same multi-national company in another country. For reasons like continued pensionary benefits and other similar reasons the employee would want to retain his contract of employment with the original employer, rather than with the seconded employer. In such agreement there are usually three parties, the employer deputing or seconding his employee, the employee and the employer to whom the employee is seconded or deputed. Such arrangements are also referred to as 'International hiring out of labour'. Section 9(1)(ii) of the Act, lays down that, Income in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s exercised. The term 'Employment is exercised' means, the place where the employee is physically present, when performing the activities, for which the employment income is paid. Article 15(2) of OECD Model Convention carves out exception to the rule in Article 15(1) by facilitating short term secondment without the burden of having to pay tax in the country, where the employment is exercised subject to the following three conditions : (a) If the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any 12 month period commencing or ending in the fiscal year concerned. and ; (b) if the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State ; and, (c) if the remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State. 14.4.1 The first condition-is not relevant as the seconded employees have been employed in India for more than 183 days. 14.4.2 The second condition-the remuneration is paid by, or on behalf of, an employer, who is not a resident of the other State. The meaning of the term 'employer' is critica ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee and the seconded employees and the correspondence between the employee and the assessee regarding bifurcation of salary payable to them. As a sample we have reproduced the contract of the assessee with Mr. Minoru Asahi hereinabove. 14.9. A reading of article 2, of the 'Agreement of employees on loan', dated August 1, 2008 between the assessee and Toyota Corporation, Japan, the request for employees on loan shall be made by a assessee in Part A of Form-1, wherein number of employees with details of the profile would be mentioned. We know that the said form one is annexed at page 507 as an annexure to the agreement of employees on loan dated August 1, 2008. 14.10. A reading of article 6, of the 'Agreement of employees on loan', dated August 1, 2008 between the assessee and Toyota Corporation, Japan, shows that the control and supervision of the seconded employee is with the assessee in India. As per Article 7 of the 'Agreement of employees on loan', dated August 1, 2008 between the assessee and Toyota Corporation Japan, the salary of expatriate employee will be paid by the Toyota Corporation, Japan, that sends the employee on deputation, and that, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the balance salary payable in Japan, by Toyota Corporation, Japan on behalf of the assessee, which shall be reimbursed by the assessee to Toyota Corporation, Japan against a debit note. 5. That, during the period of assignment with the assessee in India, all other terms and conditions as per polices of the assessee company would be applicable. Similar is the situation with all the seconded employees.' 14.15. Admittedly, the assessee deducted tax at source under section 192 of the Act, on the 100 per cent. salary paid to all the seconded employees, and paid the same to the credit of the Central Government. The assessee only reimbursed part of the salary cost of the seconded employee to Toyota Corporation, Japan that was already subjected to TDS under section 192 of the Act. And therefore, at the time of making such reimbursement, to Toyota Corporation Japan, no taxes were deducted at source by the assessee in respect of reimbursements made as, according to the assessee, it was in the nature of cost-to-cost reimbursement, and, no element of income was involved. 14.16. From a conjoint reading of article 15 of the OECD Model Convention and the articled referred to herein a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a : Provided that nothing contained in this clause shall apply in relation to any income by way of fees for technical services payable in pursuance of an agreement made before the 1st day of April, 1976, and approved by the Central Government. Explanation 1.-For the purposes of the foregoing proviso, an agreement made on or after the 1st day of April, 1976, shall be deemed to have been made before that date if the agreement is made in accordance with proposals approved by the Central Government before that date. Explanation 2.-For the purposes of this clause, 'fees for technical services' means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head Salaries .' 14.19. The definition of fees for technical services under the Act excludes 'consideration which would be income of the recipient chargeable under the head sal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld that payment made by the petitioner to the overseas entity was in the nature of income in view of the existence of service permanent establishment (PE) in India and hence liable for tax withholding. Overturning the view of the Authority for Advance Rulings that service permanent establishment was constituted, the hon'ble High Court held that the payment to associated enterprises was in the nature of 'fees for technical services' and not reimbursement of expenses and further laid down that the nomenclature of reimbursement was not decisive. It noted that : 'Money paid by the assessee to overseas entity accrues to overseas entity, which may or may not apply it for payment to secondees, based on its contractual relationship with them'. It is perceptible that in that case money paid by the Indian entity accrued to overseas entities only, which could or could not have been paid to the secondees depending upon the terms of contract. Per contra, we are confronted with a situation wherein the money never accrued to the assessee. It initially paid money to Mr. Franck in advance and then recovered the same from the Indian entity without any mark-up. There can be no que ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntrol over the deputationist's terms and employment. The concept of a service PE finds place in the UN Convention. It is constituted if the multinational enterprise renders services through its employees in India provided the services are rendered for a specified period. In this case, it extends to two years on the request of MSAS. It is important to note that where the activities of the multinational enterprise entail it being responsible for the work of deputationists and the employees continue to be on the payroll of the multinational enterprise or they continue to have their lien on their jobs with the multinational enterprise, a service permanent establishment can emerge. Applying the above tests to the facts of this case, it is found that on request/requisition from MSAS the applicant deputes its staff. The request comes from MSAS depending upon its requirement. Generally, occasions do arise when MSAS needs the expertise of the staff of MSCo. In such circumstances, generally, MSAS makes a request to MSCo. A deputationist under such circumstances is expected to be experienced in banking and finance. On completion of his tenure he is repatriated to his parent job. He retain ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ary course of its business is also not tenable. Therefore, payments made to A. T. and S by the applicant are for rendering 'services of technical or other personnel' and are in the nature of fees for technical services within the meaning of Explanation 2 to clause (vii) of section 9(1) and article 12(4) of the relevant Double Taxation Avoidance Agreement and are subject to deduction of tax at source under section 195. 14.23.1. The ruling of hon'ble Authority for Advance Rulings is on the factual finding that payments were not only reimbursement of actual salary, bonus etc., but was also included other sums. 14.23.2. Per contra in the present facts of the case, it is not at all the contention of the Revenue that, something over and above what was paid as salary, bonus etc. 14.24. Liability under section 195 to deduct tax at source when making payment to a non-resident arises only if sum paid is charge able to tax in India. Payment of salaries is not covered under section 195. Thus, it is necessary to take into consideration following aspect to determine payments to enterprise seconding employees, the Indian entity has an obligation to deduct tax source under sec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee could not held to be in default for not without tax under the provisions of the Act . . . 15. Respectfully following the above views expressed by the hon'ble Karnataka High Court in DIT (International Taxation) v. Abbey Business Services India Pvt. Ltd. [2021] 17 ITR-OL 150 (Karn), the hon'ble Authority for Advance Rulings in Cholamandalam MS General Insurance Co. Ltd. (supra), the hon'ble Bombay High Court in case of Addl. DIT v. Marks and Spencer Reliance India P. Ltd. (supra), the hon'ble Delhi High Court in the case of DIT v. HCL Info systems Ltd. [2005] 274 ITR 261 (Delhi), co-ordinate bench of this Tribunal in case of IDS Software Solutions India P. Ltd. v. ITO [2009] 122 TTJ 410 (Bang) (supra), the hon'ble Pune Tribunal in case of Faurecia Automative Holding (supra), the hon'ble Ahmedabad Tribunal in the case of Burt Hill Design (P.) Ltd. v. Dy. DIT (IT) [2017] 79 taxmann.com 459 (Ahd), we are of the view that the reimbursement made by the assessee in India to Toyota Corporation, Japan, towards the seconded employees cannot be regarded as 'Fees for technical services' and therefore not taxable under section 195 of the Act. We th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n that the expenditure is incurred on the capital assets for rearranging, shifting or realigning etc., especially when there is new production line for producing new model of car etc., the production line is essentially re-setup for new production. This issue is covered by Supreme Court decision in the case of Ballimal Naval Kishore v. CIT [1997] 224 ITR 414 (SC) where in the court applied the test propounded by Bombay High Court in the case of New Shorrock Spinning and Manufacturing Co. Ltd. v. CIT [1956] 30 ITR 338 (Bom). The test is proposed in the case by the hon'ble Bombay High Court whether a particular expenditure towards repairs to machinery or building etc., is capital or revenue. As per this decision one need to see, based on facts whether such expenditure is incurred to preserve or maintain already existing assets or it is incurred for renewal, restoration, bringing new asset into existence or bringing new (or) different advantage to the assessee. As observed based on existing facts that the factory production line was fully refurbished and made fit to manufacture new Toyota Corolla Model. Such expenditure brings new (or) different advantage and falls within the defi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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