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2014 (5) TMI 734 - AT - Income TaxTransfer pricing adjustment Determination of ALP Technical knowledge supplied to AE - Held that - The assessee had filed in the course of the TPO assessment as well as before the DRP detailed submissions, including Agreement between AE and assessee, justifying why the technical knowhow supplied by its AE was crucial to the running of its business over the sustained period of the agreement Following CIT v. EKL Appliances Ltd. 2012 (4) TMI 346 - DELHI HIGH COURT - so long as the expenditure or payment by assessee has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning they recognise that barring exceptional cases, the tax administration should not disregard the actual transaction or substitute other transactions for them and the examination of a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises - the guidelines discourage re-structuring of legitimate business transactions - The reason for characterization of re-structuring as an arbitrary exercise is that it has the potential to create double taxation if the other tax administration does not share the same view as to how the transaction should be structured. It is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity - It is also not necessary to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years - The only condition is that the expenditure should have been incurred wholly and exclusively for the purpose of business and nothing more - the assessee company maintained the necessary documentation of the international transactions as per Section 92D read with Rule 10D - The assessee company had also submitted details of the technology knowhow it obtained from its AE and the details of the Royalty payments made - The TPO has not only refuted the justification of Royalty payments but also pointed out that there was reverse flow by analyzing the deputation of personnel by the Indian company for various projects - This has been countered by the assessee specifically - The TPO has not countered that argument effectively nor is there anything on record to indicate otherwise. Once TNMM has been applied to the assessee company's transaction, it covers under its ambit the Royalty transactions in question too and hence separate analysis and consequent deletion of the Royalty payments by the TPO in the instant case seems erroneous Relying upon M/s. Cadbury India Ltd Versus Addl Commissioner of Income Tax 2014 (4) TMI 926 - ITAT MUMBAI the use of TNMM for Royalty is upheld thus, the addition made by the TPO and upheld by the DRP is unsustainable and is to be set aside Decided against Revenue.
Issues Involved:
1. Disallowance of royalty payments made to Associated Enterprises (AEs) by the Transfer Pricing Officer (TPO). 2. Application of the Comparable Uncontrolled Price (CUP) method for determining the Arm's Length Price (ALP) of royalty payments. 3. The validity of the TPO's adjustment and the CIT(A)'s partial allowance of the royalty payments. 4. The assessee's contention on the necessity and validity of royalty payments. 5. The Revenue's appeal against the CIT(A)'s decision to partially allow the royalty payments. 6. The application of the Transactional Net Margin Method (TNMM) for determining the ALP of royalty payments. 7. The relevance of the OECD guidelines and judicial precedents in determining the ALP of royalty payments. 8. The principle of commercial expediency and the TPO's authority to question the business decisions of the assessee. Detailed Analysis: 1. Disallowance of Royalty Payments: The TPO disallowed the royalty payments made by the assessee to its AE, Air Liquide, France, amounting to Rs.1,42,84,061/-, on the grounds that the payments were not at arm's length. The TPO argued that the royalty payments were not justified as the technology had been fully absorbed by the assessee, and there was no need for further payments. The TPO also noted that the payments were made for sales to AEs, which he deemed unnecessary. 2. Application of CUP Method: The TPO applied the CUP method to determine the ALP of the royalty payments and concluded that the ALP should be nil. The TPO argued that the royalty payments were not justified as the assessee had absorbed the technology and was even providing technical services to its AEs. The TPO's conclusion was based on the observation that the technology transfer agreement had expired, and the assessee was now in a position to provide technical services to its AEs. 3. CIT(A)'s Partial Allowance: The CIT(A) partially allowed the royalty payments, confirming the disallowance of 50% of the amount, i.e., Rs.71,42,031/-, and deleting the balance amount. The CIT(A) held that the assessee had not furnished sufficient details to justify the royalty payments and that part of the payments pertained to sales made to AEs. The CIT(A) also noted that the TPO had not objected to the royalty payments at 5% for sales made to non-AEs. 4. Assessee's Contention: The assessee contended that the royalty payments were made for the use of technical know-how provided by Air Liquide, France, and were necessary for its business operations. The assessee argued that the TPO had wrongly concluded that no royalty payments were required and that the payments were made for sales to independent third parties. The assessee also argued that the TPO had not followed the prescribed methodology for determining the ALP and that the payments were justified under the agreement with the AE. 5. Revenue's Appeal: The Revenue appealed against the CIT(A)'s decision to partially allow the royalty payments, arguing that the CIT(A) should have upheld the TPO's order in its entirety. The Revenue contended that the assessee had not provided sufficient details to justify the royalty payments and that the payments were not necessary as the technology had been fully absorbed. 6. Application of TNMM: The Tribunal held that the TNMM applied by the assessee covered the royalty transactions as well, and hence, a separate analysis of the royalty payments was not required. The Tribunal noted that the royalty payments were embedded in the overall transactions and could not be examined in isolation. 7. OECD Guidelines and Judicial Precedents: The Tribunal referred to the OECD guidelines and judicial precedents, including the Delhi High Court's decision in CIT v. EKL Appliances Ltd., which held that the TPO should not disregard the actual transactions undertaken by the assessee. The Tribunal emphasized that the TPO should examine the transactions as they were structured by the assessee and should not recharacterize them unless there were exceptional circumstances. 8. Principle of Commercial Expediency: The Tribunal held that the TPO had erred in questioning the commercial expediency of the royalty payments. The Tribunal reiterated that it was not for the TPO to dictate how the assessee should conduct its business or what expenditure it should incur. The Tribunal emphasized that as long as the expenditure was incurred for business purposes, it was not for the TPO to disallow it on extraneous grounds. Conclusion: The Tribunal allowed the assessee's appeals and dismissed the Revenue's appeal. The Tribunal held that the TPO's disallowance of the royalty payments was not justified and that the CIT(A) had erred in partially upholding the disallowance. The Tribunal emphasized the importance of examining the transactions as structured by the assessee and not questioning the commercial wisdom of the assessee. The Tribunal also noted that the TNMM applied by the assessee covered the royalty transactions and that the payments were justified under the agreement with the AE.
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