2013 (5) TMI 219 - AT - Income Tax

Transfer pricing adjustment on account of payment of royalty to its AE - assessee submitted that he had referred to contract manufacturing in transfer pricing analysis by mistake - Held that - Tribunal in the assessee s own case in assessment years 2003-04 and 2004-05 held that TPO was required to determine arms-length-price and then recommend adjustment which had not been done. The disallowance had been made on the ground that there was no justification for royalty which was not correct. The Tribunal therefore held that TPO exceeded its jurisdiction in making recommendation for disallowance of royalty on the ground of no justification. Even on merit no addition was required as assessee was manufacturing specific products as per specification of the principal and selling the same to principal and to other parties. The royalty was payable as per agreement for using of technical know-how on value added price to the principal as independent of manufacturing of goods. Further royalty had been paid not on entire sale price but only value added price which was worked out separately. The royalty had also been paid on sale to third parties which had been allowed but royalty on sales to AE had not been allowed when rate of royalty was the same. Further no disallowance had been made in the earlier year. Thus held by the Tribunal that the royalty was thus for the purpose of business - deleted of additions confirmed. In favour of assessee.

Summary

Issues:
Transfer pricing adjustment on account of payment of royalty.

Analysis:
The appeal was against the order of CIT(A) for the assessment year 2006-07 regarding transfer pricing adjustment made by the AO amounting to Rs.58,09,820/- for payment of royalty. The assessee, engaged in manufacturing pesticides, had an agreement with a principal for manufacturing products as per specifications and paying royalty. The TPO determined arms-length-price of royalty at nil, recommending the adjustment, as the activities were considered contract manufacturing. The AO added the amount to the income. The assessee contended that it purchased raw materials independently, bore risks, and paid sales tax, arguing against the contract manufacturing characterization. CIT(A) upheld the adjustment, emphasizing the contract manufacturing nature and lack of justification for royalty payment, leading to the appeal.

The Tribunal reviewed the case, noting similar issues in prior assessment years where the Tribunal had ruled against the disallowance of royalty. It found that the TPO had exceeded jurisdiction by recommending disallowance without determining arms-length-price. Citing a Delhi High Court judgment, the Tribunal held that the TPO's approach was incorrect. It observed that the assessee's activities were not contract manufacturing, as claimed mistakenly in the TP study. The assessee manufactured products as per principal's specifications, imported intermediaries, and paid royalty for technical know-how separately from the manufacturing cost. The Tribunal highlighted that royalty was paid on value-added price, not the entire sale price, and also on sales to third parties, not just the principal. Noting the absence of disallowance in previous years, the Tribunal concluded that the royalty was a legitimate business expense, deleting the addition made by the AO.

Based on the precedents and the factual similarity with prior years, the Tribunal allowed the appeal, setting aside CIT(A)'s order and deleting the addition of Rs.58,09,820/- made by the AO.