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TMI Blog2012 (4) TMI 346X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. 148,23,80,117/- and Rs. 1,14,59,660/- respectively. The Assessing Officer noticed that there were international transactions entered into by the assessee during the relevant previous years and accordingly invoked the provisions of Section 92CA(3) of the Act and referred the question of determination of the Arms Length Price („ALP‟, for short) to the Transfer Pricing Officer („TPO‟, for short). The TPO examined the matter in considerable detail and noticed that AB Electrolux, Sweden held 76% of the assessee‟s equity as on 31.03.2002 and out of the balance, 26% was held by the local joint venture partners and the balance 18% was held by the public. He noted that the turnover of the assessee for the assessment year 2003-04 amounted to Rs. 440.97 crores including trading sales of Rs. 48.29 crores pertaining to goods partly imported from the associated enterprises and also purchased locally. The major international transactions undertaken by the assessee were also noticed by him and he has listed the same at page 2 of the order passed by him on 20.03.2006 under Section 92CA (3) of the Act. It is noticed from the order that there are 13 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2 cr 6.78 cr 1999-2000 2.75 cr 298 cr 7.23 cr 2000-01 (39.5) cr 314 cr 6.64 cr 2001-02 (149.8) cr 481 cr 5.08 cr 2002-03 (195.1) cr. 428 cr 3.42 cr 5. From the figures shown above the TPO noticed that the assessee has been incurring huge losses year after year except for the financial year 1999-2000 and considering the perpetual losses, "the payment of royalty to the Associate Enterprise did not appear justified, as the technical knowhow/ brand fee agreements with A.E. had not benefited the assessee company in achieving profits from its operations". The TPO further noted that the assessee itself stopped the payment from 01.10.1998 till 01.01.2002 and thus "the justification for payment of brand fee during the year under reference becomes questionable". 6. Having reached the aforesaid conclusion, the TPO called upon the assessee to submit the justification for the payment of brand fee. The assessee submitted a detailed reply raising the following points: (i) The payment of brand fee should be examined on merits for each year; (ii) The Associated Enterprise („A.E.‟, for short) had received similar brand fee from M/s. Fisher and Paykel Industrie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sp; Rs. 3,42,97,940/- should be added back to the total income of the assessee. 8. A similar order would appear to have been passed by the TPO for the assessment year 2002-03 also by which the brand fee/ royalty payment on Rs. 3,99,51,000/- was added back to the income of the assessee. 9. Under Section 92CA (4) of the Act, the Assessing Officer is bound by the directions given by the TPO in respect of the ALP. Accordingly, the Assessing Officer, for both the years under appeal disallowed and added back the brand fee/ royalty payment made by the assessee to the A.E. while completing the assessments under Section 143(3) of the Act. 10. The assessee preferred appeals to the CIT (Appeals) in respect of both the assessment years and questioned the determination of the ALP and the disallowance of the brand fee/ royalty payment. The appeal for the assessment year 2002-03 was disposed of vide order dated 27.07.2009 whereas the appeal for the assessment year 2003-04 was disposed of by the order dated 27.11.2009. Though, two separate orders have been passed by the CIT (Appeals), the reasoning and conclusions are the same. We, therefore, proceed to notice the findings of the CIT (App ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5.89 crores to Rs. 397.92 crores in the year 2002; (iv) Similarly, there was increase in the depreciation costs from Rs. 6.03 crores in 1997 to Rs. 67-88 crores in 2002 on account of increase in the gross block of the assets from Rs. 46.81 crores in 1997 to Rs. 326.23 crores in 2002; (v) The figures furnished by the assessee showed that though it was deriving gross profit from the operations, it was suffering losses due to expenses and other factors. The losses show significant reduction after technical upgradation in the year 2000. Therefore, it would not be inappropriate to state that the assessee started deriving significant monetary benefits due to the technical upgradation received under the collaboration agreement with the A.E.; (vi) The OECD guidelines on Transfer Pricing Regulations require that business strategies are relevant for determining the comparability of prices between controlled and uncontrolled transactions. The TPO has disregarded the business and commercial realities and strategies and has acted in a mechanical manner ignoring the economic circumstances surrounding the transaction; (vii) It is not open to the TPO to question t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... year 2002-03 in the appeal filed by the department in ITA No.4878/Del/2009. 13. In ITA Nos.1068/2011 and 1070/2011 before us the Revenue has challenged the decision of the Tribunal by which it upheld the decision of the CIT (Appeals) deleting the disallowance of brand fee/ royalty payment for the assessment years 2003-04 and 2002-03 respectively while computing the ALP. 14. On the submissions made by both the sides, the following substantial questions of law are framed: - ASSESSMENT YEAR 2003-04 "Whether on the facts and in the circumstances of the case and on a proper interpretation of Section 92CA of the Act and Rule 10B(1)(a) of the Income Tax Rules, 1962, the Tribunal was right in confirming the order of the CIT (Appeals) deleting the disallowance of the brand fee/ royalty payment of Rs. 3,42,97,940/- made by the assessee to its Associated Enterprise, while determining the Arm‟s Length Price"? ASSESSMENT YEAR 2002-03 "Whether on the facts and in the circumstances of the case and on a proper interpretation of Section 92CA of the Act and Rule 10B(1)(a) of the Income Tax Rules, 1962, the Tribunal was right in confirming the order of the CIT (Appeals) deleting ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... their commercial or financial relations which differ from those which would be made between independent enterprises then any profit which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, if not so accrued, may be included in the profits of that enterprise and taxed accordingly. By seeking to adjust the profits in the above manner, the arm‟s length principle of pricing follows the approach of treating the members of a multi-national enterprise group as operating as separate entities rather than as inseparable parts of a single unified business. After referring to article 9 of the model convention and stating the arm‟s length principle, the guidelines provide for "recognition of the actual transactions undertaken" in paragraphs 1.36 to 1.41. Paragraphs 1.36 to 1.38 are important and are relevant to our purpose. These paragraphs are re-produced below: - "1.36 A tax administration's examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as thes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by reference to pricing) to those that might reasonably have been expected had the transfer of property been the subject of a transaction involving independent enterprises. Thus, in the case described above it might be appropriate for the tax administration, for example, to adjust the conditions of the agreement in a commercially rational manner as a continuing research agreement. 1.38 In both sets of circumstances described above, the character of the transaction may derive from the relationship between the parties rather than be determined by normal commercial conditions as may have been structured by the taxpayer to avoid or minimize tax. In such cases, the totality of its terms would be the result of a condition that would not have been made if the parties had been engaged in arm's length dealings. Article 9 would thus allow an adjustment of conditions to reflect those which the parties would have attained had the transaction been structured in accordance with the economic and commercial reality of parties dealing at arm's length." 17. The significance of the aforesaid guidelines lies in the fact that they recognise that barring exceptional cases, the tax administration shoul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. It was further observed that the rule that expenditure can only be justified if there is corresponding increase in the profits was erroneous. It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand, (1938) 6 ITR 636 that "expenditure in the course of the trade which is unremunerative is none the less a proper deduction if wholly and exclusively made for the purposes of trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense". The question whether an expenditure can be allowed as a deduction only if it has resulted in any income or profits came to be considered by the Supreme Court again in CIT v. Rajendra Prasad Moody, (1978) 115 ITR 519, and it was observed as under: - "We fail to appreciate how expenditure which is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by way of expenditure must be debited irrespective of whether there is receipt of income o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lity thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/ brand fee, because it has been suffering losses continuously. So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised. 23. Apart from the legal position stated above, even on merits the disallowance of the entire brand fee/ royalty payment was not warranted. The assessee has furnished copious material and va ..... X X X X Extracts X X X X X X X X Extracts X X X X
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