2012 (4) TMI 346 - HC - Income Tax

Arms length price Reference to TPO - Tribunal deleted the disallowance of the brand fee/ royalty payment while determining the ALP. - Tribunal hold that the royalty/ brand fee payment was justified and held that the TPO was totally wrong in disallowing the same on the footing that the assessee suffered continuous losses. Held that - There is no reason why the OECD guidelines should not be taken as a valid input in the present case in judging the action of the TPO. - 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 for the assessee 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. It is this principle that inter alia finds expression in the OECD guidelines. Even on merits the disallowance of the entire brand fee/ royalty payment was not warranted. The assessee has furnished copious material and valid reasons as to why it was suffering losses continuously and these have been referred to by us earlier. Full justification supported by facts and figures have been given to demonstrate that the increase in the employees cost, finance charges, administrative expenses, depreciation cost and capacity increase have contributed to the continuous losses. - Decided against the revenue.

Issues Involved:
1. Determination of Arm's Length Price (ALP) for brand fee/royalty payments.
2. Justification of brand fee/royalty payments despite continuous losses.
3. Application of Comparable Uncontrolled Price (CUP) method by the Transfer Pricing Officer (TPO).
4. Role of OECD guidelines in transfer pricing.
5. Authority of TPO to disallow expenses based on financial health.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for brand fee/royalty payments:
The Commissioner of Income Tax challenged the Income Tax Appellate Tribunal's (Tribunal) order for the assessment years 2002-03 and 2003-04. The assessee, a public limited company, engaged in manufacturing and trading various appliances, declared significant losses for these years. The TPO examined the international transactions, particularly focusing on the brand fee/royalty payments to AB Electrolux, Sweden, under an agreement dated 01.10.1998. The TPO found these payments unjustified due to the continuous losses incurred by the assessee and added back these amounts to the total income.

2. Justification of brand fee/royalty payments despite continuous losses:
The TPO argued that the brand fee/royalty payments did not benefit the assessee, as evidenced by the continuous losses. The assessee countered that the payments were necessary for business operations and were justified by the increase in turnover and other business factors. The CIT (Appeals) agreed with the assessee, noting that the losses were due to increased costs and other factors, not the brand fee/royalty payments. The CIT (Appeals) emphasized that the necessity and benefit of such payments should be viewed from a business perspective, not just immediate profitability.

3. Application of Comparable Uncontrolled Price (CUP) method by the Transfer Pricing Officer (TPO):
The TPO applied the CUP method to determine the ALP, concluding that the brand fee/royalty payments should be nil due to the continuous losses. The Tribunal, however, found this approach flawed, noting that the TPO disregarded the actual business transactions and the economic circumstances surrounding them. The Tribunal upheld the CIT (Appeals)'s decision that the payments were justified and necessary for the business, regardless of the losses.

4. Role of OECD guidelines in transfer pricing:
The OECD guidelines emphasize that tax administrations should not disregard actual transactions or substitute other transactions, except in exceptional cases. The guidelines discourage restructuring legitimate business transactions and recognize that business strategies and economic circumstances are crucial in determining comparability. The Tribunal and CIT (Appeals) applied these guidelines, noting that the TPO's approach was arbitrary and did not consider the business realities faced by the assessee.

5. Authority of TPO to disallow expenses based on financial health:
The Tribunal and CIT (Appeals) held that the TPO overstepped his authority by disallowing the brand fee/royalty payments based on the assessee's financial health. The financial health of the assessee is not a criterion for judging the allowability of an expense under Rule 10B(1)(a). The Tribunal emphasized that it is the assessee's prerogative to decide on business expenditures, and the TPO cannot disallow expenses solely because the assessee incurred losses. The Tribunal concluded that the disallowance was not warranted, both legally and on merits, as the assessee provided valid reasons for the continuous losses.

Conclusion:
The Tribunal confirmed the CIT (Appeals)'s decision to delete the disallowance of brand fee/royalty payments for both assessment years, finding that the TPO's approach was flawed and not supported by the OECD guidelines or relevant legal principles. The substantial questions of law were answered in favor of the assessee, and the appeals were dismissed.

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