2015 (1) TMI 921 - AT - Income Tax

Transfer pricing adjustment - most appropriate method for determination of the ALP - TNMM v/s CUP method - payment of royalty for using the technology and technical know-how - Held that - As found payment of royalty is independent of the purchase of raw materials, components, tools, packing materials, fixed assets etc. The royalty is exclusively towards the use of know-how in the manufacturing process undertaken by the assessee and is therefore not in any way interlinked or inter-connected with other transactions and it would not lead to inaccurate result if it is analyzed separately. In such a situation, we are of the opinion that the contract of payment of royalty can be analyzed separately and the ALP of such a payment can be determined independently. Where comparable uncontrolled transactions are not available, establishing arm s length price or royalty rate may not be a straight forward exercise and may require a flexible approach that need not be strictly based on specified transfer pricing methods. Therefore, in such a situation, the perfect approach for indirectly bench marking royalty payments is to bench mark the profit margin left in the tested party, after payment of lump sum fee or royalty with the profit margins of comparable uncontrolled companies. Therefore, we are of the opinion that even if the royalty payment is to be analyzed separately, TNMM is the most appropriate method for determining the ALP. The fact that the assessee was engaged in the activity of manufacture itself proves the use of technical know-how by the assessee and therefore, as held by the Hon ble Delhi High Court in the case of EKL Appliances (cited supra), the AO or the TPO cannot question the commercial expediency of the assessee or the quantum of benefit the assessee derived while making the payment. We agree with this contention of the assessee. Remand the issue for determining the ALP under the TNMM, the assessee as well as the Revenue have to search for comparable companies. Therefore, we remit this issue to the file of the AO/TPO to determine ALP of royalty by adopting TNMM after giving the assessee a fair opportunity of hearing. - Decided in favour of assessee for staistical puroses.

Issues Involved:
1. Disallowance of expenditure incurred on software.
2. Disallowance of depreciation on assets purchased on slump sale.
3. Levy of interest under sections 234B and 234D.
4. Transfer pricing adjustment related to payment of royalty.

Detailed Analysis:

1. Disallowance of Expenditure on Software:
The assessee did not wish to press ground of appeal No.2 against the disallowance of expenditure incurred on software. The Tribunal, taking into consideration the letter dated 12/11/2014 from the assessee, rejected this ground of appeal as not pressed.

2. Disallowance of Depreciation on Assets Purchased on Slump Sale:
The assessee also did not wish to press ground No.3 regarding the disallowance of depreciation on assets purchased on slump sale. The assessee filed a letter dated 12/08/2014 stating that this issue emanates from the orders passed by the AO for the assessment year 2003-04 and has consequential impact in subsequent years, including the assessment year 2008-09. The Tribunal rejected this ground of appeal as withdrawn, with liberty to the assessee to approach the Tribunal based on the outcome of the appeal filed for the assessment year 2003-04.

3. Levy of Interest under Sections 234B and 234D:
Ground Nos.4 and 5 pertain to the levy of interest under sections 234B and 234D. These issues are consequential in nature. The Tribunal set aside these issues to the file of the Assessing Officer to grant consequential relief, if any, to the assessee in accordance with the law.

4. Transfer Pricing Adjustment Related to Payment of Royalty:
The primary issue in ground No.1 relates to the transfer pricing adjustment concerning the payment of royalty. The assessee-company, established in 2002, engaged in manufacturing automatic front axle, rear axle, and propeller shaft, entered into various international transactions with its Associated Enterprises (AEs) during the financial year ending 31/03/2008. The AO accepted all international transactions to be at arm's length except for the payment of royalty, which was treated as a separate transaction. The AO adopted the Comparable Uncontrolled Price (CUP) method and applied the benefit test, arriving at the Arm's Length Price (ALP) of the royalty payment at nil. Consequently, the entire payment of royalty was brought to tax.

The assessee filed objections before the Dispute Resolution Panel (DRP), which confirmed the draft assessment order, leading to the final assessment order against which the assessee appealed.

The learned counsel for the assessee cited a similar issue in the assessee's case for the assessment year 2007-08, where the Tribunal held that royalty payment could be segregated from other transactions and that CUP is not the most appropriate method for determining the ALP of royalty transactions. The Tribunal remanded the issue back to the AO for re-determination of the ALP using the Transactional Net Margin Method (TNMM).

The Tribunal, having regard to the rival contentions and material on record, found the issue covered in favor of the assessee by the earlier order. The Tribunal reiterated that the payment of royalty is independent of other transactions and can be analyzed separately. The Tribunal emphasized that TNMM is the most appropriate method for determining the ALP of the royalty payment. The Tribunal set aside the finding of the TPO that the ALP of the royalty transaction is nil and remanded the issue to the AO/TPO for re-determination of the ALP using TNMM, after giving the assessee a fair opportunity of hearing.

Conclusion:
The Tribunal partly allowed the assessee's appeal for statistical purposes, remanding the issue of transfer pricing adjustment related to the payment of royalty to the AO/TPO for re-determination as per the directions provided. The other grounds of appeal were either rejected as not pressed or set aside for consequential relief.

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