2017 (3) TMI 106 - HC - Income Tax

Transfer pricing adjustments to royalty payment - Held that - Once it is admitted by the Revenue that the assessee entered into a royalty agreement with the AE and the assessee claimed benefit from such agreement, in the form of quantum increase in sales with no apparent increase in production, minimal product recalls and low after sales maintenance cost, and consequently paid royalty in terms thereof, it was not for the TPO to determine as to what could be the other reasons for increase in the assessee s sales and profit. Above all, there is no explanation forthcoming as to why the TPO decided upon 2% instead of the contractual rate of 3% for payment of royalty. No reason is offered by the TPO for picking on 2%. This whimsical fixation by the TPO amounts to an arbitrary and unbridled exercise of power. In consequence, we find that the TPO, having rejected the comparables cited by the assessee, did not take the trouble to examine alternate comparables so as to justify reduction of the rate for payment of royalty and by applying a wholly inapplicable methodology of determining the benefit from payment of such royalty, he capriciously reduced the rate for payment of such royalty from 3% to 2%.

Summary

Issues:
1. Whether the Tribunal was correct in deleting the addition made on account of transfer pricing adjustments to royalty payment?
2. Whether the Tribunal was correct in upholding the payment of royalty at the rate of 2% instead of 3%?

Analysis:

Issue 1:
The appeal by the Revenue under Section 260A of the Income Tax Act, 1961 challenged the order of the Income Tax Appellate Tribunal regarding transfer pricing adjustments to royalty payment. The assessee, a subsidiary of a UAE-based entity, entered into a Royalty Agreement for technical assistance. The Transfer Pricing Officer (TPO) rejected the assessee's study and reduced the royalty payment from 3% to 2%. The Dispute Resolution Panel and Assessing Officer upheld this decision. The Tribunal found flaws in the TPO's approach as no arm's length price analysis was conducted. The Tribunal allowed the appeal, stating that the reduction of royalty rate lacked a valid basis.

Issue 2:
The Revenue argued that the TPO's reasoning was justified, emphasizing the 'benefit test.' However, the Tribunal noted that the TPO did not follow prescribed methods and rejected the benefit test. The Tribunal found the TPO's reasoning unfounded and allowed the appeal. The Senior Counsel for the Revenue contended that the TPO's approach should not be dismissed lightly. In contrast, the Senior Counsel for the assessee cited legal provisions and a Supreme Court judgment emphasizing commercial expediency in determining expenditure. The High Court analyzed the TPO's rejection of comparables and arbitrary reduction of royalty rate. It concluded that the TPO's actions lacked legal basis and amounted to an arbitrary exercise of power. The High Court upheld the Tribunal's order, dismissing the appeal.

In conclusion, the High Court dismissed the appeal, finding no substantial question of law for consideration. The TPO's actions were deemed arbitrary and lacking legal basis, leading to the Tribunal's decision being upheld.