2014 (10) TMI 460 - AT - Income Tax

Transfer pricing adjustment Adoption of method - Evaluation of royalty payment, technical fees and other payments by adopting CUP method without justifying how the same was most appropriate method Held that - Whether the international transactions have to be considered separately or independently without aggregating them as part of the segment to which they relate, the term international transaction has been defined in section 92B of the Act to mean and include transactions between two or more AEs, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money or any other transaction having bearing on the profits, income, losses or assets of such enterprise. Section 92 of the Act provides that income from international transactions between AEs shall be computed having regard to ALP - the Act and the Rules contemplate determining ALP by aggregating international transactions which are multiple, interlinked or inter-related to each other and cannot be evaluated separately - To this extent the conclusions of the TPO regarding determination of ALP by taking segmental results without looking into as to whether the two segments are interlinked or inter-related cannot be sustained. The TPO has arrived at the bifurcation of the manufacturing and trading segmental operating results - the trading and manufacturing segments are interlinked and therefore a combined transaction approach has to be adopted, the results arrived at by the TPO is combined - If the segmental results are combined, the operating revenue of the assessee would be 3767.91 crores and the operating profit would be ₹ 94.34 crores - Thus, the operating profit margin on sales would be 2.517 - If the arithmetic mean of the five comparables as above is tested as against the operating profit margin on sales of the assessee at 2.517%, then the same would be within the ( )/(-) 5% range of the arithmetic mean and therefore no addition by way of adjustment to the ALP can be made Decided in favour of assessee. Computation of ALP - Whether the TPO can come to a conclusion that the ALP of an international transaction is nil because no services were rendered or that the assessee did not derive any benefit from the AE for which payments were made Held that - The conclusions of the TPO/DRP that the trading and manufacturing segment of the Assessee are distinct and not inter related warranting combined transaction approach is not correct and that a combined transaction approach has to be adopted and that on the basis of combined transaction approach the price paid for the international transaction is at Arm s Length relying upon Castrol India Ltd. v. ACIT 2013 (1) TMI 212 - ITAT MUMBAI - it was incumbent upon the TPO to work out the ALP of the relevant transactions by following some authorized method and the entire cost borne by the assessee cannot be disallowed by taking the ALP at Nil - the stand taken by the assessee in this regard deserves to be accepted - the TPO has to work out the ALP of the international transaction by applying the methods recognized under the Act - He is not competent to hold that the expenditure in question has not been incurred by the assessee or that the assessee has not derived any benefits for the payment made by the assessee and therefore he cannot consider the ALP as NIL. Determination of ALP at NIL in respect of royalty payments Held that - As decided in assessee s own case for the earlier assessment year, it has been held that the TPO s determination of the ALP of the royalty payment at nil cannot be supported - For such ALP determination, a proper analysis of comparables is required to be performed and the TPO is directed to identify suitable comparables and, after providing adequate opportunity to the appellant to determine the appropriate ALP of royalty payment Decided in favour of assessee.

Issues Involved:
1. Combined Transaction Approach for Transfer Pricing
2. Segmentation of Royalty Payment, Technical Fees, and Other Payments
3. Determination of Arm's Length Price (ALP) for Royalty Payment
4. Economic Benefit from Know-How Received from Associated Enterprises (AE)

Detailed Analysis:

1. Combined Transaction Approach for Transfer Pricing
The assessee, a subsidiary of Toyota Motor Corporation, Japan, engaged in manufacturing and trading, argued that its trading and manufacturing segments are intertwined and inter-related, warranting a "Combined Transaction Approach" in arriving at the arm's length price (ALP). The Transfer Pricing Officer (TPO) disagreed, insisting on separate evaluations for manufacturing and trading activities, citing Rule 10B(2) of the Income Tax Rules, 1962, which emphasizes applying the most appropriate method for each class of transaction.

The Income Tax Appellate Tribunal (ITAT) noted that the Act and Rules allow for determining ALP by aggregating international transactions that are interlinked or inter-related. The Tribunal referenced the OECD Guidelines and Australian Tax Office (ATO) Taxation Ruling 97/20, which support a combined transaction approach when transactions are closely linked or continuous. The Tribunal found that the TPO and Dispute Resolution Panel (DRP) failed to consider the assessee's submissions adequately. The Tribunal concluded that the trading and manufacturing segments are interlinked, warranting a combined transaction approach, and directed the TPO to compute the ALP at the entity level by combining both segments.

2. Segmentation of Royalty Payment, Technical Fees, and Other Payments
The TPO separately evaluated royalty payments, technical fees, and other payments using the Comparable Uncontrolled Price (CUP) method. The TPO concluded that the ALP for these payments was NIL, arguing that the assessee failed to demonstrate any economic benefit from the know-how received from the AE.

The Tribunal found that the TPO's approach was incorrect. The Tribunal emphasized that the TPO must work out the ALP of the international transaction by applying recognized methods under the Act and cannot determine the ALP as NIL based on the perceived lack of economic benefit. The Tribunal cited the decision of the Mumbai ITAT in the case of Dresser Rand (India) Pvt. Ltd. v. ACIT, which held that the TPO cannot compute ALP at NIL on the ground that no real services were received by the assessee or that the assessee did not benefit under a cost contribution arrangement.

3. Determination of Arm's Length Price (ALP) for Royalty Payment
The TPO determined the ALP for royalty payments at NIL, arguing that the assessee did not provide evidence of receiving technical know-how during the year, and there was no proof that other group concerns or third parties were charged identical royalty. The Tribunal found that the TPO's determination of ALP at NIL was not sustainable. The Tribunal noted that similar payments made in A.Y. 2009-10 were upheld by the DRP, which found that the assessee received technology support and related intangibles, benefiting from these technological practices and know-how.

The Tribunal held that the TPO must identify suitable comparables and determine the appropriate ALP for royalty payments. The Tribunal referenced the decision of the Hon'ble Delhi High Court in the case of CIT v. EKL Appliances Ltd., which held that the TPO cannot disregard the actual transaction or substitute other transactions for them, barring exceptional cases.

4. Economic Benefit from Know-How Received from Associated Enterprises (AE)
The TPO argued that the assessee did not derive any economic benefit from the alleged know-how received from the AE, justifying the determination of the ALP for royalty payments at NIL. The Tribunal found that the TPO's conclusion was not supported by facts and evidence. The Tribunal noted that the assessee's existence was based on the know-how provided by the AE, and there was no alternative source for obtaining automobile technology.

The Tribunal held that the TPO's determination of ALP at NIL was not justified and directed the TPO to identify suitable comparables and determine the appropriate ALP for royalty payments, considering the evidence of technology support and related intangibles received by the assessee.

Conclusion:
The appeal by the assessee was allowed, with the Tribunal directing the TPO to adopt the combined transaction approach for determining the ALP and to identify suitable comparables for determining the ALP for royalty payments. The Tribunal emphasized that the TPO cannot determine the ALP as NIL based on the perceived lack of economic benefit and must apply recognized methods under the Act.

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