2018 (9) TMI 1007 - AT - Income Tax

Transfer pricing adjustment made to the arm s length price of royalty paid to Associated Enterprise (A.E) for technical knowhow - comparable selection - Held that - As could be seen from the order passed by the Transfer Pricing Officer, referring to three agreements / comparables stated to have been selected by him on search of a particular data base, he found that the arm s length price of the royalty payment to the AE should be @ 1% of the net sales. As during the transfer pricing proceedings, in response to a show cause notice issued by the TPO, the assessee has specifically objected to the comparables proposed by the TPO by stating that none of the comparable are functionally similar to the assessee since all of them related to asset purchase agreement and further all the parties relating to such agreement are located outside India, hence, are not governed by Indian rules and regulations. The aforesaid objection of the assessee has neither been dealt with nor controverted by the Transfer Pricing Officer. Thus, when the comparable proposed by the Transfer Pricing Officer are in different geographical location we do not understand how they can be compared to the assessee. Transfer Pricing Officer having not determined the arm s length price in conformity with statutory provision and in the process having failed to demonstrate that arm s length price shown by the assessee is incorrect, the contention of the learned Departmental Representative to restore the issue to Transfer Pricing Officer for fresh determination of arm s length price is unacceptable - adjustment made to the arm s length price of royalty payment is unsustainable.- Decided in favour of assessee Addition on account of adjustment made to the arm s length price of payment to the AE towards availing Information Systems (IS) services - Held that - The material submitted before us, which also forms part of the Transfer Pricing Officer s record, indicates that the cost of the software has been allocated to 40 group companies across the globe who are using the software and related services and assessee s share in cost allocation works out to 2.3%. Moreover, when the Transfer Pricing Officer himself agrees that the AE has provided software and certain services, there is no reason for not accepting the payment made to the AE to be at arm s length in the absence of any contrary evidence brought on record and by simply applying the benefit test. If the Transfer Pricing Officer did not agree to the arm s length price shown by the assessee it was open for him to determine the arm s length price by applying one of the most appropriate methods being backed by supporting material. Without complying to the statutory provisions, the Transfer Pricing Officer certainly cannot determine the arm s length price on ad hoc / estimation basis. Our reasoning in paragraph 11 to 15 will equally apply to this issue also. We delete the adjustment made to the arm s length price of payment made towards availing information system services from AE. This ground is allowed - Decided in favour of assessee

Issues Involved:

1. Transfer Pricing Adjustment for Royalty Payment
2. Transfer Pricing Adjustment for Information Systems (IS) Services
3. Levy of Interest under Section 234B and 234C

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment for Royalty Payment:

The assessee, an Indian company engaged in manufacturing and marketing industrial flavors, fragrances, and chemical specialties, entered into a technical know-how agreement with its AE, Firmenich S.A., Switzerland. The agreement required the assessee to pay royalties at 5% on local sales and 8% on export sales. The Transfer Pricing Officer (TPO) challenged the arm's length price of the royalty payment, asserting that the assessee failed to provide detailed documentation on the intellectual properties provided by the AE. The TPO issued a show cause notice and proposed an adjustment based on external Comparable Uncontrolled Price (CUP) method, suggesting royalty should be restricted to 1% of net sales. The assessee defended the royalty payment as necessary for manufacturing and marketing, citing historical consistency and FDI policy changes. The TPO, however, determined the arm's length price at 10% of the royalty paid, amounting to ?2,01,19,124, and disallowed the rest under section 37(1) of the Act. The Dispute Resolution Panel (DRP) upheld the TPO's adjustment without addressing the alternative CUP benchmarking.

The Tribunal found that the TPO's determination of the arm's length price on an ad-hoc basis without following any prescribed method was not legally permissible. It emphasized that the TPO must determine the arm's length price using one of the methods prescribed under section 92C of the Act. The Tribunal cited judicial precedents, including the Bombay High Court's ruling in CIT v/s Johnson & Johnson Ltd., which held that the TPO's ad-hoc adjustment without applying a prescribed method was arbitrary and unsustainable. Consequently, the Tribunal deleted the adjustment made to the royalty payment, allowing the assessee's ground.

2. Transfer Pricing Adjustment for Information Systems (IS) Services:

The assessee paid ?12,96,43,330 to its AE for availing software services, capitalizing ?5,34,68,651 and claiming the balance as revenue expenditure. The TPO alleged insufficient documentation to substantiate the payment and proposed an arm's length price of ?1,62,05,000 based on an estimated man-hour rate and software cost, resulting in an adjustment of ?11,34,38,330. The DRP upheld the TPO's estimation but directed verification of the capitalized amount.

The Tribunal found that the assessee had provided substantial documentation, including agreements, invoices, and a Chartered Accountant's report, to substantiate the payment. It held that the TPO's ad-hoc determination of the arm's length price without following any prescribed method was not permissible. The Tribunal emphasized that the TPO must determine the arm's length price using one of the methods prescribed under section 92C of the Act. The Tribunal deleted the adjustment made to the IS services payment, allowing the assessee's ground.

3. Levy of Interest under Section 234B and 234C:

The levy of interest under sections 234B and 234C was deemed consequential and did not require specific adjudication.

Conclusion:

The Tribunal allowed the assessee's appeal partly, deleting the adjustments made for royalty payment and IS services while dismissing grounds not pressed and considering the levy of interest as consequential.

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