2011 (5) TMI 365 - AT - Income Tax

International transaction - Addition - Royalty - the explanation offered by the assessee justifying increase in the rate of royalty of carcass grade of products was not accepted by the TPO and adopting the rate of royalty at 2 per cent on the said product as arm s length price he held that the royalty paid by the assessee in excess of 2 per cent was liable to be disallowed - the arm s length price needs to be determined by the most appropriate method determination of which would depend inter alia on the nature of transactions functions performed by the associated enterprise etc. Rule 10C(2) of Income-tax Rules 1962 - if the facts of the present case are considered in the light of the above factors CUP method cannot be regarded as most appropriate method for determining arm s length price of the royalty paid by the assessee to M/s Cabot Corporation USA as there is no data available in respect of uncontrolled transactions which are similar or at least closely similar to the transactions of the assessee company with its associated enterprise Cabot Corporation USA - Appeal is allowed by way of remand to AO Regarding royalty - Revenue or capital expenditure - It may also be pertinent to note here that a similar payment of royalty under the same technology agreement was made by the assessee right from the year 1990 and the deduction claimed for the same as revenue expenditure was allowed consistently by the Department in the earlier years - It was held that the intention of the assessee was to acquire technical knowledge or know-how for certain period and the drawings acquired were part of technical knowledge. It was held that the assessee thus did not acquire any asset or benefit of enduring nature and the payments made under the agreement were allowable as revenue expenditure - Appeal is partly allowed

Summary

Issues Involved:

1. Transfer Pricing Adjustment.
2. Treatment of Royalty Expenditure as Capital or Revenue Expenditure.

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment:

The common issue in the assessee's appeal and ground No. 2 of the Revenue's appeal pertains to the addition of Rs. 2,06,48,218 made by the Assessing Officer on account of transfer pricing adjustment, which the CIT(Appeals) sustained to the extent of Rs. 1,37,65,579. The assessee, an Indian company engaged in manufacturing carbon black, paid royalty to its parent AE, Cabot Corporation, USA. The royalty rates were increased over time, and the total payment for the year under consideration was Rs. 5,62,67,860.

The Transfer Pricing Officer (TPO) questioned the increase in the royalty rate for the Carcass product from 2% to 5%, noting no change in the technology terms and rejecting the justifications provided by the assessee. The TPO concluded that the royalty payment in excess of 2% was not justified and disallowed the excess amount.

The CIT(Appeals) partially agreed, reducing the disallowance by adopting a 3% royalty rate for the Carcass product, aligning it with the rate for Trade Grade products.

Upon further appeal, the Tribunal noted that the issue was whether the royalty rate was at arm's length. The Tribunal found that the CUP method used by the assessee was not appropriate due to the lack of comparable uncontrolled transactions. Therefore, the Tribunal set aside the CIT(Appeals) and Assessing Officer's orders and directed the Assessing Officer to reassess the arm's length price using the most appropriate method, considering the unique nature of the product and technology involved.

2. Treatment of Royalty Expenditure as Capital or Revenue Expenditure:

The Revenue challenged the CIT(Appeals)'s deletion of the entire addition of Rs. 5,62,67,879 made by the Assessing Officer, who treated the royalty expenditure as capital expenditure. The Assessing Officer believed the royalty was paid for acquiring technology, providing an enduring advantage, and thus capital in nature, relying on the Supreme Court decision in Southern Switch Gear Ltd. v. CIT.

The CIT(Appeals), however, found that the royalty payments were for improving the efficiency and profitability of the existing business, not for acquiring an asset or advantage of enduring nature. The CIT(Appeals) cited the Supreme Court decision in Alembic Chemical Works Co. Ltd. and Bombay High Court decisions, which supported treating such payments as revenue expenditure.

The Tribunal upheld the CIT(Appeals)'s decision, noting that the royalty payments had been consistently allowed as revenue expenditure since 1990, including in proceedings under section 263 for assessment year 2003-04. The Tribunal emphasized the rule of consistency and found no reason to treat the royalty payments as capital expenditure.

Separate Judgments Delivered:

There were no separate judgments delivered by the judges in this case. The decision was delivered as a single composite order by the Tribunal.