2019 (2) TMI 1790 - AT - Income Tax

TP Adjustment - determination of the royalty payment at Rs. Nil by using the benefit test - HELD THAT - We find that the assessee has used the technology supplied by its AE for in its manufacturing process and for such use of technology it has paid the royalty. A.O has applied the benefit test and observing that the assessee failed to prove the benefit derived by it by use of such technology he has disallowed the entire expenditure by treating the arm s length price at Nil. We find that such an issue had arisen before the Coordinate Bench of the Tribunal at Bangalore in the case of M/s. Toyota Kirloskar Auto Parts Pvt Ltd Vs. ACIT 2015 (1) TMI 921 - ITAT BANGALORE held that so long as expenditure payment has been demonstrated to have been incurred or laid out for the purpose of business it is no concern of the TPO to disallow the same on any extraneous reasoning and as provided in the OECD guidelines he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but wholesale disallowance of the expenditure is not contemplated or authorized thus set aside the finding of the TPO that the ALP of the transaction of royalty is nil - 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 As decided in M/S. RAK CERAMICS INDIA PRIVATE LIMITED 2017 (12) TMI 191 - ITAT HYDERABAD once it is admitted by the Revenue that the assessee entered into a royalty agreement with the AE and the assessee claimed benefit from such agreement in the form of quantum increase in sales with no apparent increase in production minimal product recalls and low after sales maintenance cost and consequently paid royalty in terms thereof it was not for the TPO to determine as to what could be the other reasons for increase in the assessee s sales and profit. . Above all there is no explanation forthcoming as to why the TPO decided upon 2% instead of the contractual rate of 3% for payment of royalty. No reason is offered by the TPO for picking on 2%. This whimsical fixation by the TPO amounts to an arbitrary and unbridled exercise of power. A.O cannot determine the royalty at Nil. Therefore we remit the issue to the file of the AO/TPO with a direction to determine the arm s length price of royalty by adopting TNMM as the most appropriate method and adopting the suitable comparables. Needless to mention that the assessee shall be given a fair opportunity of hearing. Accordingly the appeal of the assessee is treated as allowed for statistical purposes.

Summary

Issues Involved:

1. Determination of Arm's Length Price (ALP) of royalty payment.
2. Application of the benefit test by the Transfer Pricing Officer (TPO).
3. Jurisdiction of the TPO in questioning commercial expediency.
4. Methodology for determining ALP and use of comparables.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) of Royalty Payment:
The primary issue in the appeal was the determination of the ALP for the royalty payment made by the assessee to its Associated Enterprise (AE). The assessee argued that the royalty payment should not be determined at Rs. Nil, citing previous judgments where the benefit test was not adopted. The Tribunal referenced the case of M/s. Toyota Kirloskar Auto Parts Pvt Ltd Vs. ACIT, where it was held that the ALP should not be determined at Rs. Nil without proper comparables. The Tribunal emphasized that the TPO did not provide any comparables to justify the ALP determination at Rs. Nil and relied solely on the benefit test, which was not appropriate.

2. Application of the Benefit Test by the TPO:
The TPO had applied the benefit test, concluding that the assessee failed to prove the benefit derived from the use of the technology, and thus disallowed the entire royalty expenditure. The Tribunal found this approach flawed, as it was not necessary for the assessee to demonstrate the benefit derived from the expenditure. The Tribunal cited the Delhi High Court's decision in EKL Appliances, which held that the benefit test cannot be used to question the commercial expediency of the expenditure.

3. Jurisdiction of the TPO in Questioning Commercial Expediency:
The Tribunal reiterated that the TPO's role is limited to determining the ALP of the transactions and not to question the commercial decisions of the assessee. The Tribunal referenced multiple cases, including IWM Constructions Pvt Ltd and RAK Ceramics India Pvt Ltd, where it was held that the TPO cannot deny the deduction of payments by questioning the commercial expediency. The Tribunal emphasized that the TPO overstepped his jurisdiction by questioning the necessity and benefit of the royalty payment.

4. Methodology for Determining ALP and Use of Comparables:
The Tribunal highlighted the need for proper methodology and comparables in determining the ALP. It referenced the case of RAK Ceramics India Pvt Ltd, where the TPO's arbitrary reduction of the royalty rate from 3% to 2% without providing alternate comparables was deemed inappropriate. The Tribunal directed the TPO to adopt the Transactional Net Margin Method (TNMM) and search for suitable comparables to determine the ALP of the royalty payment.

Conclusion:
The Tribunal concluded that the TPO and AO were incorrect in determining the ALP of the royalty payment at Rs. Nil and questioning the commercial expediency of the payment. The issue was remitted to the AO/TPO to determine the ALP using TNMM and suitable comparables, ensuring the assessee is given a fair opportunity of hearing. The appeal was allowed for statistical purposes, and the judgment was pronounced on 15th February 2019.