2013 (12) TMI 1356 - AT - Income Tax

Transfer pricing adjustment on account of payment of royalty Held that - Following M/s. SC Enviro Agro India Pvt. Ltd. Versus Dy. Commissioner of Income tax 2012 (11) TMI 1107 - ITAT MUMBAI - there was no justification for payment of royalty on the ground that it was a case of contract manufacturing - under transfer pricing provisions, the 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 royalty was payable as per agreement for using of technical know-how on value added price to the principal - Thus royalty payment was independent of manufacturing of goods - 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 - no disallowance had been made in the earlier year the order of CIT(A) set aside Decided 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 2007-08 concerning transfer pricing adjustment made by the AO on payment of royalty amounting to Rs.54,05,834. The assessee, engaged in manufacturing pesticides, had an agreement with a Japanese principal for manufacturing products as per specifications, with royalty payable at 5% of sale price. The TPO determined arms-length-price of royalty at nil, recommending an adjustment of Rs.54,19,026 due to the nature of contract manufacturing. The AO added this amount. The assessee contended that it purchased materials independently, bore risks, and sold goods to approved parties, disputing the contract manufacturing characterization. CIT(A) upheld the adjustment, citing the nature of activities and sales primarily to the principal.

In the Tribunal, the assessee's counsel referenced previous cases where similar royalty payments were allowed. The Tribunal noted discrepancies in the TPO's approach, citing the requirement to determine arms-length-price before recommending adjustments. It referenced a Delhi High Court judgment disapproving such TPO methods. The Tribunal found the royalty payment justified as it was for technical know-how, not manufacturing, and was based on value-added price. It noted no disallowance in prior years and ruled the royalty was a legitimate business expense. Consequently, the Tribunal reversed the CIT(A)'s decision, deleting the addition based on the precedent set in the assessee's earlier cases.

In conclusion, the Tribunal allowed the appeal, setting aside the CIT(A)'s order and deleting the addition made on account of royalty payment. The decision was based on the Tribunal's prior rulings in the assessee's cases for assessment years 2003-04 and 2004-05, establishing the legitimacy of the royalty payment under the agreement with the principal.