2016 (6) TMI 123 - AT - Income Tax

Transfer pricing adjustment - international transaction of Payment of royalty - whether no addition on account of transfer pricing adjustment is permissible as the AO has not made any disallowance u/s 37(1)? - Whether application of the TNMM on entity level should be upheld covering the international transaction of payment of royalty? - MAM - Held that - Coming to the determination of ALP of this international transaction under the CUP method, we find that the assessee chose three companies as comparable, which, in our considered opinion, have been rightly rejected by the TPO on several cogent reasons tabulated vide para 14 of his order including difference in type of technology and different geographical locations inasmuch as both the payers and payees were foreign parties. However, the fact remains that if the assessee s comparables are not correct and the assessee is not forthcoming with a new set of comparables, then, it becomes the duty of the TPO to find out relevant comparables and proceed to determine the ALP accordingly. Coming back to the TPO s opinion about nil ALP of the payment of royalty, we find that the DRP has accepted the marginal use of technical know-how by the assessee from its AE, for which it directed to adopt 0.25% on sales as the ALP of royalty payment in respect of this model. It is this ad hoc approach of the DRP which has been turned down by the Tribunal for the earlier years leading to the restoration of the matter to the file of AO/TPO for a fresh determination of the ALP of this transaction by using the transaction by transaction approach, which the assessee has done for this year by applying the CUP method in respect of the international transaction of payment of royalty. As the facts and circumstances for the instant year continue to remain similar vis- -vis the preceding years, respectfully following the precedent, we set aside the impugned order and remit the matter to the AO/TPO for a fresh determination of the ALP of the international transaction of Payment of royalty for model 3DX by applying the CUP method after affording a reasonable opportunity of being heard. - Decided in favour of assessee for statistical purposes.

Issues Involved:
1. Addition on account of transfer pricing adjustment for the payment of royalty.
2. Benchmarking method for international transactions.
3. Application of the Comparable Uncontrolled Price (CUP) method versus the Transactional Net Margin Method (TNMM).
4. Determination of Arm's Length Price (ALP) for royalty payments.
5. Applicability of Section 37(1) of the Income-tax Act, 1961.

Detailed Analysis:

1. Addition on Account of Transfer Pricing Adjustment for the Payment of Royalty:
The primary issue in this appeal is the addition of ?156,38,82,889/- made by the Assessing Officer (AO) on account of transfer pricing adjustment. The assessee, an Indian subsidiary of a UK-based company, paid royalty to its associated enterprise (AE) for the product 3DX. The Transfer Pricing Officer (TPO) disputed this payment, arguing that the product 3DX was merely a replication of an older model, 3D, whose patent had expired. The TPO determined the Arm's Length Price (ALP) of the royalty payment to be Nil, leading to a transfer pricing adjustment of ?164.74 crore. The Dispute Resolution Panel (DRP) later adjusted this to 0.25% of sales, resulting in the final addition of ?156.38 crore.

2. Benchmarking Method for International Transactions:
The assessee initially used the Transactional Net Margin Method (TNMM) for benchmarking its international transactions but later employed the Comparable Uncontrolled Price (CUP) method specifically for the payment of royalty. The TPO and DRP, however, found inconsistencies in the comparables chosen by the assessee under the CUP method, and the DRP directed a minimal ALP of 0.25% on sales.

3. Application of the CUP Method versus the TNMM:
The tribunal has consistently held that the benchmarking of international transactions should be done on a transaction-by-transaction basis, rather than aggregating all transactions under the TNMM. The CUP method was deemed more appropriate for the royalty payment transaction. The TPO rejected the comparables chosen by the assessee under the CUP method due to differences in technology and geographical locations.

4. Determination of ALP for Royalty Payments:
The TPO initially determined the ALP of the royalty payment to be Nil, arguing that the assessee did not derive any significant benefit from the payment. The DRP, however, acknowledged some marginal use of technical know-how and directed an ALP of 0.25% on sales. The tribunal found this ad hoc approach unacceptable and remanded the matter back to the AO/TPO for a fresh determination of the ALP using the CUP method.

5. Applicability of Section 37(1) of the Income-tax Act, 1961:
The assessee argued that no addition on account of transfer pricing adjustment is permissible as the AO did not make any disallowance under Section 37(1). The tribunal referred to the judgment in CIT v. Cushman & Wakefield (India) (P.) Ltd., which held that the TPO's authority is limited to determining the ALP of an international transaction, while the AO must decide on the deductibility under Section 37(1). The tribunal found that the AO and TPO's actions were inconsistent with this precedent and remanded the matter for reconsideration.

Conclusion:
The tribunal set aside the impugned order and remitted the matter to the AO/TPO for fresh determination of the ALP of the international transaction of payment of royalty for the model 3DX using the CUP method, in line with the tribunal's earlier decisions and the jurisdictional High Court's judgment in Cushman & Wakefield (India) (P.) Ltd. The appeal was allowed for statistical purposes.

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