2016 (4) TMI 1456 - AT - Income Tax

TP Adjustment - Determination of ALP of royalty transactions at NIL against transaction value - AR submitted that TPO has determined the ALP holding that the taxpayer did not produce any cost benefit analysis at the time of entering into the agreement with its AE showing that the royalty rate is not fixed based on expected benefit - HELD THAT - Assessee has entered into technical assistance agreement with Stanley Electric Company Japan on 01.04.2007 for grant of nonexclusive and nontransferable license without a right to sub-license to manufacture and sale license product in India using the technical information of Stanley Electric Company. Since 1990 the royalty is being paid by the Assessee to Stanley @3% of sales. During the period from 1990 to 1994 the two parties were unrelated party hence the royalty contract was made under uncontrolled conditions and the payment of royalty by the Assessee to AE can be considered as comparable uncontrolled price for the purpose of bench marking the royalty payment for the year. Accordingly Assessee in its TP Study report has said that the payment of royalty is at Arm s length price as the agreement is in accordance with industrial policy of the Govt. In its TP study report assessee applying the TNMM method and submitted that the above transaction is also conducted at an ALP. On the identical facts and circumstances in the case of the assessee in 2015 (10) TMI 2509 - DELHI HIGH COURT has not admitted the appeal of the revenue with respect to the determination of ALP of royalty relying on the decision of CIT Vs. EKL Appliances Ltd. 2012 (4) TMI 346 - DELHI HIGH COURT and CIT Vs. Sony Ericson Mobile Communication 2015 (3) TMI 580 - DELHI HIGH COURT held that royalty payment cannot be disallowed on the basis of the so-called benefit test and the domain of the TPO is only to examine as to whether the payment based on the agreement adheres to the arm s length principle or not - we direct the ld. TPO/AO to delete the adjustment made on account of ALP of royalty payments. Disallowance u/s 14A r.w.r. 8D - mandation of recording satisfaction - HELD THAT - Recording of satisfaction on the correctness of claim of the assessee on disallowance u/s 14A before invoking rule 8 D of the Income tax rules 1962 is mandatory. The language of section 14A provides that AO must record a satisfaction if he was unsatisfied with any incorrect claim of the assessee. If he failed to record such a finding then it cannot be said that he rightly invoked provision of section 14A of the act for application of rule 8D. See Taikisha Engineering India Ltd 2014 (12) TMI 482 - DELHI HIGH COURT Also assessee had own funds far in excess of the amount invested in investments earning tax free income. In such a case presumption is that own funds have been used to finance the investment activities. As in case of CIT Vs. Reliance Utilities and Power Ltd. 2009 (1) TMI 4 - BOMBAY HIGH COURT has held that when interest free funds are available then the presumption would be that such interest free funds are invested or advanced as interest free loan. If the presumption is applied to the facts of this case then there cannot be any disallowance on account of interest expenditure. Therefore on two counts i.e. non-recording of satisfaction and interest free fund far in excess of investments we do not incline to uphold disallowance made u/s 14A - Decided in favour of assessee.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) of royalty transactions.
2. Disallowance under Section 14A of the Income Tax Act.
3. Disallowance of provision for leave encashment under Section 43B.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) of Royalty Transactions:
The primary issue revolves around the ALP determination of royalty payments made by the assessee to its associated enterprise (AE), M/s. Stanley Japan. The Transfer Pricing Officer (TPO) determined the ALP of the royalty transaction to be NIL, leading to an adjustment of Rs. 6,69,57,682/-. The TPO's rationale included the absence of evidence on how the royalty rate was fixed, lack of cost-benefit analysis, and no proof of economic benefit derived from the know-how received from the AE.

The assessee argued that the royalty payment was based on a technical assistance agreement since 1984, predating the AE relationship, and that the royalty rate was within the limits specified by the Reserve Bank of India and the Foreign Exchange Management Act. The assessee also cited a previous favorable decision by the Hon'ble Delhi High Court in its own case, where similar issues were resolved in favor of the assessee.

The Tribunal noted that the agreement between the assessee and Stanley Japan was approved by the Government of India and the Reserve Bank of India. Additionally, the Tribunal referred to the consistent acceptance of the royalty payments in previous years and the application of the Comparable Uncontrolled Price (CUP) method and Transactional Net Margin Method (TNMM) by the assessee in its Transfer Pricing study. The Tribunal found that the TPO's application of the "benefit test" was not in accordance with the prescribed methods under Section 92C of the Income Tax Act and directed the deletion of the adjustment of Rs. 6,69,57,682/-.

2. Disallowance under Section 14A:
The assessee had disallowed a sum of Rs. 12,66,605/- suo moto under Section 14A of the Income Tax Act. However, the Assessing Officer (AO) applied Rule 8D and made a further disallowance of Rs. 16,59,069/-. The assessee contended that the AO did not record any reasons for dissatisfaction with the disallowance already made by the assessee and that there was no direct nexus established between borrowed funds and investments.

The Tribunal observed that the AO had not recorded any satisfaction regarding the correctness of the assessee's claim before invoking Rule 8D. Citing various judicial precedents, including the Hon'ble Delhi High Court's decision in I.P. Support Services India (P) Ltd vs CIT, the Tribunal emphasized the mandatory requirement of recording satisfaction. Additionally, the Tribunal noted that the assessee had sufficient own funds to cover the investments, invoking the presumption that own funds were used for investments. Consequently, the Tribunal directed the deletion of the further disallowance of Rs. 16,59,069/-.

3. Disallowance of Provision for Leave Encashment under Section 43B:
The assessee did not press this ground, and hence, it was dismissed.

Conclusion:
The Tribunal allowed the appeal of the assessee in part, directing the deletion of the adjustments related to the ALP of royalty payments and the further disallowance under Section 14A, while dismissing the ground related to the disallowance of provision for leave encashment under Section 43B.