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2011 (6) TMI 449 - AT - Income TaxRoyalty payment - Revenue Expenditure or Capital Expenditure - CIT bifurcated 75% of royalty expenditure as revenue expenditure and the balance as capital expenditure - Held that - Tribunal in relation to assessee s earlier AYs had held that running royalty payable has no nexus or direct connection with the manufacture of the product. The liability to pay the royalty arises only when there is a sale. Therefore, running royalty cannot be said to be a capital expenditure. We do not find any rationale in bifurcation of the running royalty and treating one part as capital and the other part as revenue without any basis - Decided in favor of Assessee Transfer pricing - addition made on account of revision of ALP - transactions with related parties - Held that - As far as purchase of raw materials are concerned determination of ALP by assessee cannot be faulted, since it had proceeded based on CUP method, which was rejected by the TPO and A.O. for wrong reasons. Further, not only the TPO had unilaterally adopted TNM method, but made comparisons with the working results of a concern which was not comparable at all - Decided against the revenue With respect to purchase of finished goods - Held that - Assessee has committed two fundamental mistakes in working out the ALP based on resale price method. It went by its internal gross profit rate averaged over two years, that too without excluding the purchases and sales from the associated enterprises. Neither the A.O. nor the TPO went into this aspect but simply applied TNM method, that too based on a single comparable, which as already mentioned by us was not comparable at all. Matter set aside to AO - Decided in favor of Revenue for statistical purposes.
Issues Involved:
1. Classification of royalty expenditure as revenue or capital expenditure. 2. Adjustment towards arm's length price for international transactions. Issue-wise Detailed Analysis: 1. Classification of Royalty Expenditure: The assessee claimed Rs. 2,75,24,000/- as revenue expenditure for royalty payments made to M/s Chevron Oronite Company LLC, USA (COCL). The Assessing Officer (A.O.) classified this as capital expenditure but allowed depreciation. The Commissioner of Income Tax (Appeals) [CIT(A)] directed that 75% of the royalty expenditure be considered as revenue expenditure, and 25% as capital expenditure. Both the assessee and the Revenue appealed against this decision. The Tribunal referenced its own prior decision in the assessee's case for assessment years 1999-2000 to 2002-03, where it was held that running royalty payments, computed as a percentage of sales, should be treated as revenue expenditure. The Tribunal found no rationale in bifurcating the running royalty into capital and revenue parts, as the liability to pay royalty arises only upon sales, making it a revenue expenditure. Consequently, the Tribunal allowed the assessee's appeal and dismissed the Revenue's related ground, thus classifying the entire royalty payment as revenue expenditure. 2. Adjustment Towards Arm's Length Price: The second issue involved the adjustment of Rs. 1,22,19,429/- towards the arm's length price (ALP) for international transactions. The assessee had transactions with related parties, including purchases and sales of raw materials and finished goods, and liaison activities with associated enterprises in Singapore, France, and the USA. The Transfer Pricing Officer (TPO) challenged the ALP determination methods used by the assessee, which included the Comparable Uncontrolled Price (CUP) method and the Resale Price Method. The TPO applied the Transactional Net Margin (TNM) method using financials from M/s Interflon India Pvt. Ltd. (IIP) as a comparable. The TPO's analysis led to an upward adjustment of Rs. 1,22,19,429/-. The CIT(A) found that IIP, involved in the food industry, was not comparable to the assessee, which operated in the automobile industry. The CIT(A) also noted the significant difference in turnover and business operations between the two companies and deleted the addition. The Tribunal agreed with the CIT(A) regarding the non-comparability of IIP with the assessee, highlighting the substantial differences in financial data and business activities. The Tribunal found that the TPO had erroneously rejected the CUP method for raw materials and applied the TNM method based on an incomparable entity. For finished goods, the Tribunal noted that the assessee's resale price method did not exclude transactions with associated enterprises, making it inappropriate. The Tribunal upheld the CIT(A)'s deletion of the adjustment for raw materials but remitted the issue of ALP determination for finished goods back to the A.O. for reconsideration, directing that the A.O. proceed in accordance with the law. Summary of Results: - The appeal of the assessee is allowed, classifying the entire royalty payment as revenue expenditure. - The Revenue's appeal is partly allowed for statistical purposes, with the adjustment for raw materials upheld in favor of the assessee and the issue of finished goods remitted back to the A.O. for reconsideration.
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