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2012 (11) TMI 1107 - AT - Income TaxTP - Determination of arms length price - disallowance of Royalty amount - whether contract manufacturer or an independent manufacturer - safe harbor limit of /- 5% - Held that - Hon ble Delhi High Court in the case of CIT vs. EKL Appliances in ITA No.1068/70/2011 - assessee is having proper license to manufacture products and hence cannot be considered as contract manufacturing - royalty has to be made for technology transfer which was approved by the RBI at 5% on value addition made by assessee in the manufacturing process - The rule does not authorize the TPO to disallow any expenditure on the ground that it was not necessary or prudent for assessee to have incurred the same - As royalty is paid for allowing assessee in utilizing the technical knowhow and the license for manufacturing activity - the payment of royalty is wholly and exclusively for the purpose of business - Hence Royalty is allowed as claimed - decided in favor of assessee TP adjustment shall be within the safe harbor limit of /- 5% - The TPO determined ALP at NIL which is at 100% variation - 5% royalty rate is at arm length price - assessee s payment of royalty cannot be disallowed invoking the TP provisions - Decided in the favor of assessee
Issues Involved:
1. Determination of whether the assessee is a contract manufacturer or an independent manufacturer. 2. Legitimacy of the royalty payment to SCCL and its arm's length price. 3. Validity of reopening the assessment under section 147. Issue-wise Detailed Analysis: 1. Determination of whether the assessee is a contract manufacturer or an independent manufacturer: The assessee argued that it was not a contract manufacturer but an independent manufacturer, having obtained technical knowhow for manufacturing insecticides and pesticides. The assessee admitted to mistakenly claiming in the Transfer Pricing (TP) report that the arrangement was in the nature of contract manufacturing. The Tribunal noted that the TPO (Transfer Pricing Officer) did not examine the nature of the agreement or the manufacturing activity, but rather took the TP report statement at face value. It was concluded that the assessee was indeed an independent manufacturer, as evidenced by its significant assets and sales to outside parties, and not merely a contract manufacturer. 2. Legitimacy of the royalty payment to SCCL and its arm's length price: The TPO had disallowed the royalty payment, determining its arm's length price at NIL, on the grounds that the assessee was a contract manufacturer and thus did not need to pay royalty. The Tribunal referenced the Delhi High Court's decision in CIT vs. EKL Appliances, which held that the TPO cannot disallow an expenditure on the grounds of necessity or prudence. The Tribunal found that the royalty payment was made for the use of technical knowhow and was approved by the RBI at 5%. It was determined that the royalty payment was wholly and exclusively for the purpose of business and should be allowed in full, including for sales to associated enterprises (AEs). The Tribunal also noted that the CIT (A) had erroneously restricted the royalty payment to sales made to third parties. 3. Validity of reopening the assessment under section 147: The assessee challenged the reopening of the assessment under section 147, arguing that the original reason for reopening (deemed dividend under section 2(22)(e)) was not pursued in the final assessment. The Tribunal agreed, citing the Bombay High Court's decision in CIT vs. Jet Airways (I) Ltd, which held that if the income referred to in the reasons for reopening is not assessed, the AO cannot assess other income. Since the deemed dividend issue was dropped, the Tribunal held that the reopening of the assessment was invalid. Conclusion: The Tribunal allowed the appeals, directing the AO to allow the royalty payments as claimed and holding that the reopening of the assessment was invalid. The Tribunal emphasized the importance of examining the actual business profile and agreements of the assessee rather than relying solely on statements in the TP report. The decision reinforced the principle that the TPO's role is to determine the arm's length price, not to question the business rationale behind transactions.
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