2024 (7) TMI 849 - HC - Income Tax

TP adjustments - payment of royalty - payments made by STI India to Samsung Korea - Samsung Telecommunications India STI , the respondent-assessee, was incorporated as a wholly owned subsidiary of Samsung Electronics Co. Ltd., Korea Samsung Korea Sale of goods manufactured by STI to its AEs - DRP concluded that STI was acting as a contract manufacturer because it had not been remunerated as if it were an independent manufacturer that utilized intangibles in the form of technical know-how in its own right to independently manufacture goods which would eventually be sold to group entities - ITAT deleted addition HELD THAT - STI was operating as a contract manufacturer on behalf of Samsung Korea for the following reasons. A perusal of the facts on the record reveals that STI was a wholly owned subsidiary of Samsung Korea and which was engaged in the manufacture and sale of mobile handsets under the brand name of Samsung in the Indian and overseas market and which would invariably involve sale of the said goods to its AEs as well. The transfer of technical know-how and licensing of technology was essential to enable STI to undertake its activities independently. Neither the TPO nor the DRP engaged in a recharacterization of the transaction entered into between the parties nor was there any material existing on the record to demonstrate that the transaction entered into between STI and its AEs was distinguishable from those which would have been entered into by independent enterprises behaving in a commercially rational manner. Neither the TPO nor the DRP rested their opinion on any material or evidence which may have tended to indicate that the transactions undertaken by STI would not satisfy the test of commercial expediency or prudence. Neither the production of the goods in question nor the supply thereof was shown to be motivated or based upon directives of Samsung Korea. Those transactions clearly appear to have been guided and informed by STI s business and commercial interests. The mere factum of STI being a wholly owned subsidiary of Samsung Korea does not necessarily entail that it was engaged in the manufacture and sale of mobile handsets solely at the behest and directives of Samsung Korea or having undertaken that exercise as a contract manufacturer. Samsung Korea, during A.Y. 2008-09, was stated to have been in receipt of a technical assistance fee and royalty from STI necessary for the latter to engage in its manufacturing activities. There was no material placed on the record to show that the manufacture and sale of the aforenoted goods by STI was dependent on directives issued by Samsung Korea or even that STI was contractually obliged to manufacture goods on behalf of Samsung Korea. STI does not fall under the ambit of a contract manufacturer either in terms of the OECD Guidelines, 1995 or for that matter the OECD Guidelines, 2022. There has been no material adduced on the record to demonstrate that STI receives any extensive instructions about what to produce, in what quantity and of what quality or that it is performing any low risk service for Samsung Korea or any of the AEs . Unable to agree the entire transaction between STI and its AEs was meant to operate as a profit shifting mechanism, merely because independent entities were charged a higher price in comparison with the AEs of STI. In our view, it would be erroneous to conclude that the sale of goods manufactured by STI to its AEs was done with a view to shift profits across jurisdictions, even if the price of royalty was embedded in the sale price of the goods sold to its AEs. STI was engaged in the manufacture of goods as per its own volition and not as per the directives of Samsung Korea and undertook decisions related to the manufacture and sale of goods independent of Samsung Korea. As a result, Samsung Korea cannot be deprived of the right to obtain an arms length return on the utilization of its patented or proprietary technology and know-how. This in light of the undisputed fact that the latter could not have engaged in the manufacture and sale of goods without the technological know-how provided by Samsung Korea. In our considered opinion, the observations rendered by the DRP with regard to the contrast between the gross profit earned by STI on export sales to AEs and to other independent entities ought to be appreciated while bearing in mind the distinguishable characteristics underlying those sale transactions and which would have in turn been dependent upon the nature of the products, features of the mobile phones, the individual value of the mobile handsets and other distinguishing factors. In the absence of specific data pertaining to the said transactions or of any evidence suggesting that Samsung Korea was in control of the overseas sales by STI to AEs or unrelated parties, we find ourselves unable to conclude that the AEs of STI had not been charged for the cost of technological know-how obtained or that STI had not been renumerated as an independent manufacturer by its AEs . TPO as well as the DRP clearly appear to have misconstrued the agreement in terms of which know-how and expertise stood licensed to STI. Decided against revenue.

Summary

Issues Involved:
1. Whether the ITAT erred in deleting the TP adjustments of Rs. 1,99,57,161/- on the ground of payment of royalty in the circumstances of the case.

Issue-wise Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for Royalty Payments:
The Principal Commissioner challenged the ITAT's decision to delete the Transfer Pricing (TP) adjustments related to royalty payments made by STI to Samsung Korea. The Transfer Pricing Officer (TPO) had determined the ALP of royalty paid by STI for exports as 'Nil', asserting that STI acted as a contract manufacturer for Samsung Korea. This view was upheld by the Dispute Resolution Panel (DRP), which noted that STI had not charged its Associated Enterprises (AEs) for technical know-how and had embedded the value of the said intangible in the sale price of goods sold to independent parties.

2. Contract Manufacturer vs. Licensed Manufacturer:
The Tribunal, in its decision for AY 2007-08, had concluded that STI was a full-fledged licensed manufacturer and not a contract manufacturer. This conclusion was based on the findings that STI received technical know-how from Samsung Korea, operated independently, and engaged in sales driven by open market conditions. The Tribunal found no evidence to suggest that STI was mandated to sell goods to its AEs or that its entire production was assured to be purchased by Samsung Korea.

3. Economic Substance of the Transaction:
The TPO and DRP's stance was that STI, being a wholly owned subsidiary of Samsung Korea, had no justification for paying royalty, as it amounted to paying royalty "to itself." However, the Tribunal found that the royalty payments were for the receipt of technical know-how and expertise, which was essential for STI's manufacturing activities. The Tribunal also noted that the TPO had not provided any specific reason to doubt the benefits derived by STI from the royalty payments.

4. Powers of the TPO:
The Court highlighted that the TPO's authority is limited to examining the appropriateness of the method adopted for determining ALP or evaluating comparables. The TPO does not have the jurisdiction to question the commercial expediency or genuineness of the need for the transaction. This principle was affirmed by the Court in previous judgments, including Commissioner of Income-tax v. EKL Appliances Ltd.

5. OECD Guidelines on Contract Manufacturing:
The Court referred to the OECD Guidelines, which define contract manufacturing as involving extensive instructions on production and an assurance that the entire output will be purchased. The Court found that STI did not fall under this definition, as there was no evidence of extensive instructions or an assurance of purchase from Samsung Korea.

6. Comparison of Gross Profit Margins:
The DRP had observed that STI's gross profit on sales to AEs was lower than that on sales to independent parties, suggesting that the value of intangibles was embedded in the sales price to independent parties. However, the Court noted that this observation did not account for the distinguishable characteristics of the transactions, such as the nature of products and market conditions.

7. Arm's Length Principle and Royalty Payments:
The Court emphasized that Samsung Korea, as the owner of the technical know-how, was entitled to an arm's length return on the value of the intangibles provided to STI. The Tribunal had found that the royalty payments were made at arm's length and were necessary for STI's manufacturing activities.

Conclusion:
The Court dismissed the appeal, concluding that the Tribunal was justified in deleting the TP adjustments related to royalty payments. The Court held that STI operated as a licensed manufacturer and not as a contract manufacturer, and the royalty payments were made at arm's length for the receipt of technical know-how from Samsung Korea. The TPO and DRP's conclusions were found to be based on erroneous assumptions and a misinterpretation of the transaction's economic substance.