2016 (11) TMI 123 - HC - Income Tax

Transfer pricing adjustment - bench marking - Whether the Tribunal was right in holding that royalty and technical assistance fee did not form part of a composite transaction and have to be treated as two separate transactions for the purpose of benchmarking and computing arms length price? - Held that - Undoubtedly the assessee was obliged to make the payment and that obligation arose from the agreements, a pre-incorporation binding contract. However, that such contractual obligation existed cannot ipso facto be the end of the enquiry. ALP determination in respect of every payment that is part of an international transaction is to be conducted irrespective of such obligation undertaken by the parties. If the transactions are, in the opinion of the TPO, not at arm s length, the required adjustment has to be made, as provided in the Act, irrespective of the fact that the expenditure is allowable under other provisions of the Act. There can conceivably be various reasons not to subject such payments, such as for instance, if no similar data exists at all; or that sectional data for such payments is absent. Quite possibly, this may also be a general pattern of expenditure which AEs may insist to part with technology; further, similarly, other models of payment- deferred or lump sum, along with royalty or inclusive of it, may be discerned in comparable transactions. However, to say that such a substantial amount had to necessarily be paid and that it was a commercial decision, dictated by need for the technology, in the light of a specific query, it could not be said by the assessee that later profits justified it, or that has essentiality precluded the scrutiny. This court holds that the explanation by the assessee that the payment of ₹ 38.58 crores in the circumstances was correctly not accepted. The first question is answered against the assessee. The remit directed by the impugned order is, therefore, upheld. Transactional Net Margin Method applied for benchmarking/computing arm s length price in respect of transaction relating to technical assistance fee - Held that - This court concurs with the assessee that having accepted the TNMM as the most appropriate, it was not open to the TPO to subject only one element, i.e payment of technical assistance fee, to an entirely different (CUP) method. The adoption of a method as the most appropriate one assures the applicability of one standard or criteria to judge an international transaction by. Each method is a package in itself, as it were, containing the necessary elements that are to be used as filters to judge the soundness of the international transaction in an ALP fixing exercise. If this were to be disturbed, the end result would be distorted and within one ALP determination for a year, two or even five methods can be adopted. This would spell chaos and be detrimental to the interests of both the assessee and the revenue. The second question is, therefore, answered in favour of the assessee; the TNMM had to be applied by the TPO/AO in respect of the technical fee payment too.

Summary

Issues Involved:
1. Segregation of royalty and technical assistance fee as separate transactions for benchmarking and computing arm's length price (ALP).
2. Applicability of the Transactional Net Margin Method (TNMM) versus the Comparable Uncontrolled Price (CUP) method for benchmarking technical assistance fee.

Detailed Analysis:

Issue 1: Segregation of Royalty and Technical Assistance Fee
The High Court examined whether the Income Tax Appellate Tribunal (ITAT) was correct in treating royalty and technical assistance fee as separate transactions for benchmarking and computing ALP. The assessee, a Joint Venture Company, had categorized multiple international transactions under one broad head for benchmarking using the TNMM. The Transfer Pricing Officer (TPO) rejected this entity-level approach, arguing that each transaction should be benchmarked separately. The ITAT upheld this view, stating that combined benchmarking of all international transactions is not in accordance with law. The ITAT also noted that the assessee used projected operating profit margins rather than actual figures, which is incorrect under Rule 10B(4). The High Court concurred, emphasizing that the initial burden is on the assessee to prove that international transactions are at arm's length. The court held that the explanation for the payment of technical assistance fees was correctly not accepted, and the remit directed by the ITAT was upheld.

Issue 2: Applicability of TNMM versus CUP Method
The second issue was whether the ITAT was right in rejecting the TNMM for benchmarking the technical assistance fee and instead applying the CUP method. The TPO had accepted TNMM for other international transactions but applied the CUP method for the technical assistance fee, determining its ALP as nil. The ITAT found this approach flawed, stating that when technical information was admittedly obtained, it could not be said that the assessee should not have paid any consideration. The High Court agreed with the ITAT, noting that the TPO should have sought comparable uncontrolled transactions for a proper CUP method application. The court emphasized that once a method is accepted as the most appropriate, it should be applied consistently across all transactions. The High Court concluded that the TPO's selective application of the CUP method for the technical assistance fee was incorrect. The second question was answered in favor of the assessee, affirming that TNMM should have been applied for the technical fee payment as well.

Conclusion:
The High Court dismissed the appeal, upholding the ITAT's decision to remand the case for fresh determination of ALP by the TPO/AO while applying the TNMM consistently across all transactions, including the technical assistance fee.