2018 (3) TMI 954 - AT - Income Tax

TPA - ALP determination - addition on account of royalty paid to Johnson Matthey UK, AE - not accepting TNMM as the most appropriate method considering the business model and transaction of the assessee - Held that - The transaction of payment of royalty is flowing from a separate agreement and has to be paid to JM-UK irrespective of any services or goods received and is entirely a separate transaction having no remote connection with the other transactions; and therefore, bundled approach for aggregation to transfer all the transaction under TNMM would not be desirable on the facts of the present case. Accordingly, we reject the contention of the Ld. Counsel before us that payment of royalty should be aggregated with the other transactions and needs to be benchmarked under TNMM. The payment of royalty cannot be determined at NIL . The parties negotiate the rates depending upon the complexity existing in particular industry, nature of technical knowhow and keeping other relevant economic factors. The rates given by the RBI, which are quite often fluctuating, cannot constitute a comparable data for external CUP, as it merely gives the range of the royalty rate for the money which can be remitted to a Foreign Entity. Thus, we are of the opinion that rate prescribed by RBI under FEMA regulation cannot be reckoned as an external CUP for the purpose of benchmarking. Here in this case neither the assessee nor the AO has searched for any external CUP; and therefore, we deem fit that the issue of benchmarking of royalty payment should be remanded back to the file of the AO/TPO to benchmark royalty payment separately by using external CUP. The data from Royalty Stat available for automotive industry can be used for search of external comparables and the payment of royalty paid for use of technical knowhow for manufacturing of automotive components can be used for the purpose of benchmarking. The onus would be on the assessee to carry out the fresh search process and after selecting external comparables and carrying out comparability analysis may present the same to the TPO, who shall analyse the external comparables and benchmark the royalty payment of the assessee. With this direction the issue of royalty payment is set aside to the file of the AO/TPO and the TPO who shall give appropriate opportunity of hearing to the assessee to substantiate the ALP of the said transaction. For intra group services under the arm s length principle in this case the intra group services like server charges, SAP maintenance charges and cost sharing charges is an operating cost for overall manufacturing activities carried out by the assessee, because these expenses are quite essential for any independent enterprise and also for efficiency for the business activities. Regarding cost sharing charges, we will endeavour to examine the nature of various intra group services , as to whether actually such services at all has been rendered which can said to be part of the operating cost and whether assessee has derived some benefit while carrying out its manufacturing / business activities or not. Under the arms length scenario no independent enterprise will pay to a third party in a foreign country where it has not been able to show that any sale has been made to the customers or any such services has rendered for the customers in that foreign country. For benchmarking such a payment one has to see, whether any independent Indian party would pay to a foreign entity when neither it has it any customers nor has it been established that any such services have been rendered by the foreign entity which can have some commercial expediency benefitting the Indian company. Thus, under arms length conditions also such a payment does not stand the test of ALP; and accordingly, we confirm the order of the TPO that the payment of sales commission to AE is not meant either for business purpose or under the arms length conditions such a payment is justified. Accordingly, the amount of ₹ 1,08,48,310/- is confirmed. So far as SAP maintenance charges his payment being a part of the operating cost has to be aggregated under the TNMM. Here in this case it is not in dispute that, assessee s profit margin vis- -vis the comparables under TNMM is higher and therefore, no separate adjustment is required on this expense. For the cost sharing charge Such cost sharing arrangements has to be treated as part of the operating cost of the assessee company and therefore, under TNMM no separate benchmark should be done for this service as it can be factored in arriving at net profit margin. Accordingly, we hold that no separate addition should be made on cost sharing charges . Thus, in view of our finding given above, TPO is directed to give effect and determine the arm s length price accordingly. In the result appeal of the assessee as well as of the department for assessment year 2007- 08 is partly allowed for statistical purposes. Server charges is definitely inextricably linked with the business activities and is an operating cost of the assessee, therefore, no separate benchmarking is required as the same will be aggregated under TNMM. Accordingly, no separate addition or adjustment is warranted. Thus, appeal for the assessment year 2008-09 and 2009- 10 are treated as partly allowed. Sales tax subsidy to be treated as capital receipt not chargeable to tax.

Summary

Issues Involved:
1. Acceptance of TNMM as the most appropriate method for benchmarking international transactions.
2. Determination of arm’s length price (ALP) for intra-group services.
3. Treatment of sales tax subsidy as revenue or capital receipt.
4. Separate benchmarking of royalty payments.

Detailed Analysis:

1. Acceptance of TNMM as the Most Appropriate Method:
The assessee argued that the Transactional Net Margin Method (TNMM) should be accepted as the most appropriate method for benchmarking its international transactions, given its business model and transactions. The Transfer Pricing Officer (TPO) rejected this and applied the Comparable Uncontrolled Price (CUP) method for specific transactions, including intra-group services and royalty payments.

2. Determination of ALP for Intra-Group Services:
The assessee challenged the TPO's decision to determine the ALP for various intra-group services as NIL, arguing that these services provided substantial benefits. The intra-group services in question included:
- Sales commission to Johnson Matthey Japan and UK.
- Cost-sharing charges for regional headquarters in Malaysia.
- SAP maintenance charges.

The TPO and the Commissioner of Income Tax (Appeals) [CIT(A)] held that the assessee failed to demonstrate tangible benefits from these services, leading to the determination of the ALP as NIL. The Tribunal upheld the TPO's decision for sales commission but accepted the assessee's arguments for cost-sharing and SAP maintenance charges, recognizing them as part of operating costs and thus aggregable under TNMM.

3. Treatment of Sales Tax Subsidy:
The assessee argued that the sales tax subsidy received from the Haryana Government should be treated as a capital receipt, not taxable under Section 28(iv) of the Income Tax Act. The Assessing Officer (AO) treated it as a revenue receipt. The CIT(A) upheld the AO's decision, but the Tribunal reversed this, following the precedent set by the Delhi High Court in the assessee’s own case for the previous assessment year, which treated the subsidy as a capital receipt.

4. Separate Benchmarking of Royalty Payments:
The TPO determined the ALP of royalty payments to Johnson Matthey UK as NIL, arguing that the assessee did not demonstrate substantial benefits from the payments. The CIT(A) reversed this, accepting the royalty rates as per industry standards and RBI/FIPB approvals. The Tribunal held that the benchmarking of royalty payments should be done separately using the CUP method, not aggregated under TNMM. The Tribunal remanded the issue back to the TPO for fresh benchmarking using external CUP.

Conclusion:
The Tribunal provided a mixed verdict:
- TNMM: Accepted as the most appropriate method for overall benchmarking but not for specific transactions like royalty payments.
- Intra-Group Services: Upheld the TPO's determination of NIL ALP for sales commission but accepted the assessee's arguments for cost-sharing and SAP maintenance charges.
- Sales Tax Subsidy: Treated as a capital receipt, not taxable.
- Royalty Payments: Directed fresh benchmarking using the CUP method, rejecting aggregation under TNMM.

The Tribunal’s decision emphasizes the importance of detailed documentation and justifiable benefits for intra-group services and royalty payments in transfer pricing assessments.