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TMI Blog2013 (11) TMI 194X X X X Extracts X X X X X X X X Extracts X X X X ..... manufacturing, the payments have to be considered as revenue expenditure as the acquirer does not obtain any asset of enduring nature - It was only the acquisition of information, guidance or payment for consultancy which is received by way of drawing and design and explains how the production process was to be carried on which will result into only revenue expenditure and not for acquisition of any capital asset - The amendment w.e.f 1.4.98 had not alter the situation - Whatever are capital expenditure which were in the nature of intangible assets and which were not eligible for depreciation earlier, were only now eligible for claim of depreciation u/s 32 but cannot be expended to mean that what were revenue expenditure was now to be treated as capital expenditure after the amendment Thus, the amount being revenue expenditure, was allowable as such u/s 37(2) of the Act. Relying upon Commissioner Of Income-Tax, Bombay City I Versus Tata Engineering And Locomotive Co. Pvt Limited [1979 (2) TMI 20 - BOMBAY High Court ] - The assessee merely acquired technical know-how so that it could manufacture the products as required but such know-how was not in relation to setting up of the pla ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... operation to be carried on more efficiently or more profitably - No interference is required in the order of the CIT(A) for deleting the disallowance of expenditure incurred on training of the employees. Additions Made u/s 92CA(3) - Whether the CIT(A) had erred in deleting the addition made by the A.O. on account of TPO-1's order u/s 92 CA(3) dated 21.02.2005 on account of adjustments in the ALP of international transactions of the assessee – Held that:- Sec. 92C(1) referred to ALP in relation to an international transaction - Rule 10B(1)(e) read with section 92C deals with TNMM, and it refers to only net profit margin realized by an enterprise from an international transaction or a class of such transaction, but not operational margins of enterprises a whole. The net margins on the transaction was the basis of comparison - Only in cases where profits of an enterprise were attributable to similar transactions and when an enterprise does not have any other transaction or activity which was not similar, and which distorts the profits, then probably the net margin derived by an enterprise may also be the net margin of a transaction - In other words, when in an enterprise, only simila ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hey are heard together and are being disposed of by way of this common order. 2. Facts in brief - The assessee is a public limited company and is promoted by Denso Corporation, Japan (Denso Japan). Denso Japan holds 47.93% equity in the assessee company and the overall management and controls rests with Denso Japan. Sumitomo Corporation, which is primarily a trading company, holds only 10.27% equity in the assessee company. For the year under assessment, the assessee filed its income tax return on October 30, 2002 declaring total income of Rs. 19,44,45,442/-. The return was originally processed under sec. 143(1) of the Income-tax Act, 1961 (the Act) vide intimation dated February 25, 2003 and thereafter was taken up for scrutiny by issue of a notice under section 143(2) dated October 22, 2003. The Ld. Additional Commissioner of Income Tax, Range 10, New Delhi (AO) was pleased to complete the assessment under section 143(3) of the Act vide her order dated March 30, 2005 on a total income of Rs. 27,17,76,470/-. 3. The Assessing Officer made certain additions and disallowances as well as adjustment under the Transfer Pricing Provisions. First Appellate Authority deleted the same. Ag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... using technology and patents of the Japan Foreign company. Right to manufacture allowed in the agreement entered into by the assessee with Denso Corporation, had nexus with receipt of technical information. Payment of Royalty during the current year is made on the basis of the same agreement that was considered by the Delhi Bench of the Tribunal in the case of the assessee for the A.Y. 2001-02. The Tribunal vide its order dated 20th March, 2008 in ITA No. 4798/Del/2004, has held as under:- "7. With regard to ground taken by the revenue for deleting the addition of Rs. 3.29 crores on account of royalty paid. The issue is squarely covered in favour of the assessee by the order of ITAT in assessee's own case for assessment years 1988-89 to 1997-98. During the year under consideration also, the CIT(A) has rightly deleted the addition after recording finding with reference to the terms of the agreement which were similar to the terms of agreement during the course of earlier years. The Tribunal has deleted the disallowance. Following are the findings of the Tribunal in assessee's own case: "A perusal of the above case law will show that case of the assessee is entirely covered by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the amount claimed by the assessee becomes less than 7% and the amount will be allowable. Apart from it the payment as noted by Their Lordships in the case of Tata Robins Frazer Ltd. v. CIT (supra) the amount comes from the circulation of the capital and not from any capital asset. Further we may refer the decision of the Apex Court in the case of Gotan Lime Syndicate v. CIT[1966] 59 ITR 718 in which it was also laid down that the amount of royalty has to be allowed as revenue expenditure, as the said expenditure was in relation with the excavation of raw material. More you take the more royalty you pay. This ratio is again applicable in the case as amount of royalty in the case is directly linked with the volume of contract products. The more assets will produce, the amount of royalty will increase. In case assessee stops manufacturing of contract products the amount of royalty will not be payable. In view of the above ratio the amount of royalty which is linked with the volume of production is allowable as revenue expenditure. On the basis of above discussion the cumulative result is that amount of royalty being paid was allowable as, revenue expenditure in view of the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... new factory after obtaining know how from its German collaborators, which collaboration was being considered by the High Court. In principle, it would seem to make no difference between a case where an existing company undertakes a totally new line of activity for which it has to establish a new factory, and a case where for manufacturing a new product a new company is constituted or formed. What we have to consider is whether the payment has been made for acquiring an asset of an enduring nature, if know-how has been acquired unrelated to secret or patented processes or the right to use the trade name or trade mark, then the acquirer of that know-how - since that phrase was repeatedly used or emphasized - would seem to acquire no asset of an enduring nature. If the know-how acquired relates to the setting up of the plant or machinery, then perhaps it decide that question in the present reference. If the know-how acquired relates to the process of manufacturing, then the payment made for the same would have to be considered as revenue expenditure, since the acquirer does not obtain by the expenditure any asset of an enduring nature. It is only the acquisition of information, guida ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company is newly set up or an existing one will not make any difference. The answer is also available in the decision rendered by Hon'ble Bombay High Court in the case of Gannon Norton Metal Diamond Dies Ltd. (supra). The Hon'ble High Court held that if the know-how acquired relates to the process of manufacturing, then the payment made for the sale would have to be considered as revenue expenditure since the acquirer does not obtain any asset of an enduring nature. The Hon'ble Supreme Court in the case of Empire Jute Co. Ltd., 124 ITR 1 = (2002-TIOL-238-SC-IT) held that in a case where expenditure even if incurred for obtaining an advantage of enduring benefit, may, none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be held as capital expenditure. If the advantage consists merely in facilitating the assessee's trading operation or enabling the manag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at were to be charged for this service were not mentioned. He held that the assessee company was not liable to make payments to Denso Haryana Pvt. Ltd. towards sharing of communication network called "NICE-NET" (Nippon Denso Integrated Communication Earth Network). The first appellate authority brought out the arguments of the assessee in Para 10.33 which read as under:- "10.3.3 The appellant in its submission stated that they entered into the agreement with Denso Haryana Pvt Limited for using the NICE - NET network on cost sharing basis for reporting and communication recharged to Denso Group Companies world over. Further, the said expenses were paid to Denso Haryana Pvt Limited, who has shown the said receipts as income during the year under consideration. It is further submitted that Denso Haryana Pvt Ltd. has been assessed under the same jurisdiction. Further, there is no dispute that the services were rendered and actually used by the appellant company during the year under consideration. The AO erred in concluding that the appellant had not obtained RBI approval in respect of the agreement for use of "NICE-NET" Network entered into between the appellant and DNHA as no such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... phold the finding of the AO that the expenditure in question cannot be allowed, as the cost sharing agreement is a sham agreement. When costs are being shared, we do not understand as to how specific charges or quantification of charges are asked to be mentioned in the agreement. Non-mentioning of the same in the agreement cannot be a ground for disallowance. No R.B.L approval was required or payments were made in India. The Assessing Officers of Denso Haryana Pvt. Ltd. and the assessee are the same. When Denso Haryana Pvt. Ltd. made a payment of Rs. 10,41,434/- to a foreign company, the AO has not doubted that expenditure. When Denso Haryana Pvt. Ltd. is recovering a part of the expenditure from the assessee, cost reduction is accepted but the expenditure is doubted in the hands of the assessee. When an understanding is arrived at between different entities, the A.O. cannot sit in judgment as to the date of implementation etc. On these facts, we are of the opinion that the disallowance is made based on conjectures and surmises. Thus, we uphold the finding of the CIT(A) though for different reasons. 13. Ground No. 6 is on the disallowance of technical service expenses being paid t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aid by treating the same as intangible assets. This verdict of the CIT(A) was accepted by the assessee and no appeal was filed before the Tribunal. 9. With regard to the amount of Rs. 63.46 lakhs the assessee claimed it as revenue expenditure which was disallowed by the Assessing Officer on the plea that it was capital in nature. By the impugned order, the CIT(A) confirmed the action of the Assessing Officer and allowed only depreciation thereof u/s 32(1) which was also accepted. The assessee preferred an appeal before ITAT and the ITAT had allowed the assessee's appeal and allowed the said amount in full as revenue expenditure in ITA. No. 4714/Del/2004. Thus to the extent, the ground taken by the revenue is misconceived. So far as the amount of Rs. 63.46 lakhs is concerned, the same is covered by the order of ITAT in assessee's own case, respectfully following the same to this extent, we do not find any reason to interfere in the order of CIT(A)." 16. The first appellate authority followed the order of the Tribunal and in Para 10.6.3 of his order, held as follows:- "10.6.3 I have gone through the submission and contention of the appellant and have also perused the order of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... same as capital expenditure in nature. 8. On the facts and circumstances of the case and in law, the order of the CIT(A) has erred in deleting the addition of Rs. 62,10,292/- made by the AO on account of payment of knowhow fees treating the same capital in nature. 9. On the facts and circumstances of the case and in law, the order of the CIT(A) has erred in deleting the addition of Rs. 13,13,332/- made by the AO on account of NECNET charges paid to Denso Haryana for use of the internet. 10. On the facts and circumstances of the case and in law, the order of the CIT(A) has erred in deleting the addition of Rs. 1,00,02,674/- paid to Denso Corporation, Japan, for technical services & training treating the same as revenue expenditure in spite of capital expenditure treated by the AO. 11. On the facts and circumstances of the case and in law, the order of the CIT(A) has erred in deleting the addition of Rs. 64,19,573/- made by the AO on account of deduction u/s 35AB." 19. In A.Y. 2003-04 ground No. 7 is same as ground No. 3, ground No. 8 is same as ground No. 4, ground No. 9 is the same as ground No. 5, ground No. 10 is same as ground No. 6 and ground No. 11 is same as ground ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (PLI) as the most appropriate method to establish that the international transactions entered into by it are at arm's length. The tested party is the assessee itself, i.e., assessee's net profit margin over the cost has been compared with the margin of other comparable companies in India engaged in similar function. 4.1 During the year, assessee has imported raw materials amounting to Rs. 49,86,69,729/- from Sumitomo Corporation, Japan (SCJ) out of the total import of Rs. 57,77,00,221/-. It means that purchases from SCJ constituted approximately 86.3% of the total imports and 37.5% of total raw material consumed. It was submitted during the course of proceedings that SCJ is a trading company and does not manufacture any of the items supplied to the assessee during the year under consideration. It was also stated that the majority of the items supplied by SCJ to the assessee were actually manufactured by various Denso group entities. The SCJ held 10.27% shares in the assessee company during the financial year 2001-02. The assessee has not considered purchases from SCJ to be an international transaction because SCJ is not an Associated Enterprise by virtue of owning less than 26% s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... il Price Method (RPM); (c) it clearly emerges that no method other than the CUP can be applied in this case to determine the ALP of the import of the components from SCJ. 23. As the assessee has not brought out any difference between the quality of components purchased from the A.E. and quality of components purchased from uncontrolled domestic suppliers, the TPO held that the ALP of imports from A.E. could be determined by comparing it with the prices of uncontrolled domestic suppliers. 24. In case of certain components the indigenization took place in the subsequent years the TPO held that the prices of these goods in the subsequent years were to be taken and used as comparables. 25. The TPO while using CUP method compared the prices of four components purchased locally during the F.Y. 2001-02 and took the prices of seven other components purchased locally during the next F.Y. i.e. 2002-03. In other words the TPO has used data of future years, in case of 7 components. 26. On appeal the first appellate authority endorsed the findings of the AO that Sumitomo Japan is an A.E. of the assessee as per section 92A of the Act and that the transactions entered by the assessee with Sum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... determining the arm's length nature of the appellant's international transactions of import of raw material and components from Sumitomo Japan." Thereafter he determined the arm's length price by adopting operating profits by sales as a profit level indicator and after making comparison with 13 companies held that the appellant's international transactions with A.E. are at arm's length. He held that TNMM is to be used as most appropriate method. 28. Aggrieved the Revenue is in appeal on the following grounds:- "1. On the facts and in the circumstances of the case and in law, the CIT(A) has erred in deleting the addition of Rs. 1,36,31,665/- made by the A.O. on account of TPO-1's order under Section 92 CA(3) dated 21.02.2005 on account of adjustments in the ALP of international transactions of the assessee. 2. On the facts and in the circumstances of the case and in law, the CIT(A) has erred in accepting the additional grounds of appeal submitted by the assessee before him during the course of assessment proceedings, without giving any reasonable opportunity to the Transfer Pricing Officer or the Assessing Officer as required in Rule 46A(3) of the IT. Rules to rebut the eviden ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... zed on a transaction-by-transaction basis as all the transactions were incidental and ancillary to the main operation of manufacture of automotive components. He supported bench marking of international transactions at the entity level by adopting operating profit/total cost (OP/TC) as the relevant profit level indicator. 31. He further submitted that no external or internal Comparable Uncontrolled Price (CUP) was available to the assessee for benchmarking on a stand-alone basis. The reasons given for not adopting CUP method are (a) reliable information on external CUPs could not be obtained; (b) ALP per unit price of uncontrolled enterprises is substantially dependent upon factors such as volume, contractual terms, locational differences etc. (c) It is not possible to estimate with reasonable reliability and accuracy, the combined effect on per unit prices in case of external comparables & (d) Abstract factors such as use of intangibles, etc. makes the use of the CUP method difficult for benchmarking purpose. 32. Supporting application of TNMM method the learned counsel for the assessee relied on the following:- (1) TP Guidelines for Multinational Corporation and Tax Administr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the import of raw material, import of capital goods, payment of royalty, payment of know-how fees, payment of short stay expenses and testing fees as well as procurements of raw-material domestically are transactions which are inextricably integrated and that separate results for each transaction cannot be computed and hence entity level profit level Indicator (PLI) is to be taken for the purpose of bench marking and that such methodology is permitted under TNMM. In support of his contention, he relied on AS-17 i.e. Segment Report as well as Para 3.10 of OECD Guidelines. 35. The second limb of the argument is that the valuation of the goods has been accepted by the Custom Authorities and hence the imports were at ALP. Reliance was placed on the judgment of Hon'ble Delhi High Court in the case of CIT v. Samsung India Electronics Ltd.[2011] (Mag. He also relied on the order of Delhi Bench of Tribunal in the case of Coastal Energy (P.) Ltd. v. Asstt. CIT[2011] 46 SOT 286 (URO) and the judgment in the case of Maruti Suzuki India Ltd. v. Addl. CIT[2010]. 36. After considering rival contentions we hold as follows - The submission of the assessee that under the Transactional Net Margi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... only difference is that, in the RPM and CPM methods, comparison is of margins of gross profit and whereas in TNMM the comparison is on margins of net profit. TNMM requires comparison between net margins derived from the operations of the uncontrolled parties and net margins derived by an AE from similar operations. Net margin is indicated by the rate of return on sales or cost of operating assets, and this forms the basis for TNMM. A functional analysis of the tested party or the independent enterprise, as the case may be, is required to determine whether the transactions are comparable and the adjustments that are required to be made to obtain reliable results. The tested party would have to consider other factors, like cost of assets comparable companies, etc., while applying the return on assets measure. Ordinarily, the test party, has to be the party provided services because it is on the basis of rate of return on sales cost or operating assets that transactional margin is computed. These parameters generally available in the case of a party providing services." 69. Under the TP Regulations the following steps are to be taken to determine the TNMM: Step 1: The net profit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. A functional analysis of the associated enterprise and, in the latter case, the independent enterprise is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results. Further, the other requirements for comparability, and in particular those of paras 3.34 to 3.40, must be applied." 71. Para 3.42 of TP Guidelines for Multinational Enterprises and Tax Administrations issued by OECD reads as follows : "3.42 An analysis under the TNMM should consider only the profits of the associated enterprise that are attributable to particular controlled transactions. Therefore, it would be inappropriate to apply the transactional net margin method on a company-wide basis if the company engages in a variety of different controlled transactions that cannot be appropriately compared on an aggregate basis with those of an independent enterprise. Similarly, when analyzing the transactions between the independent enterprises to the extent they ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re development. So the comparable of another assessee also only in software development was considered sufficient. This was a case of aggregation of similar transactions and where the assessee had no other transactions. In our case, 50 per cent of the assessee's production is from APIs imported from the AE and whereas the balance is production from APIs which are not imported from AE. There is also trading activity. Thus, we are unable to accept the contentions of Shri Rajan Vora. 71B. We are surprised that the assessee does not want to come out with information or documentation to demonstrate that a transaction or a class of transaction can be evaluated for the purpose of comparison. Though the assessee is a 100 per cent subsidiary of UCB S.A., Belgium, the parent company does not seem to be interested in giving proper support to the subsidiary company by way of furnishing data on comparables. After the lapse of so many years, we do not know what were the reasons that prevented the parent company from sharing the data on uncontrolled transactions entered into by it for the very same ingredients. Such a data would have gone a long way in concluding the issue. Only it was at the t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... issue in this case is whether the most appropriate method is TNMM method or CUP method. The AO applied CUP method and rejected the TNMM method adopted by the assessee. The Assessing Officer gave reasons for rejecting the TNMM which are extracted in para 22 of this order. The issue whether the assessee has correctly applied TNMM method or not was the subject matter of discussion and for the reason given the method itself was rejected. In any event when the assessee wrongly applies provisions of the Act and Rules, the Tribunal has power to point out the mistake. If the Assessing Officer does an act which is patently against the statute and rules, the Tribunal cannot endorse such an action. This is not the case where the Ld.D.R. has gone beyond the orders passed by the AO. It is a case where the Ld.T.P.O. has rejected TNMM. Hence, this argument is rejected. 38. The assessee imports raw-materials and components. In our view the most appropriate method is the CUP method as held by the TPO. The Mumbai Bench of ITAT in the case of Serdia Pharmaceuticals (India) (P.) Ltd. (supra) has held as follows:- "59. That takes us to the question as to whether, on the facts of this case, the CUP m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unique contribution in relation to controlled transaction, or where the parties engage in highly integrated activities ". This change in OECD approach is quite in line with Indian transfer pricing legislation which requires selection of most appropriate method rather than the method being picked up in the order of priority. To this extent, the approach of OECD and Indian transfer pricing legislation is now quite in harmony with each other. 63. It will, however, be stretching the things too far to suggest that in the 2010 version of OECD Guidelines, all the methods of determining the arm's length price have been placed at par with each other. The change in the OECD Guidelines, as we see it, is in respect of the order in which suitability of the methods is to be considered and in recognition of the fact that there can be situations in which transactional profit methods can have an edge over traditional transactional methods. However, wherever transactional profit methods as also traditional transactional methods can be applied in equally reliable manner, the OECD Guidelines still consider the traditional transactional methods to be preferable, as is evident from following observati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of conditions in financial and commercial terms are attributed to inter relationship between the associated enterprises, and it is this impact of interrelationship between the associated enterprises that is sought to be neutralized by the transfer pricing regulations. As long as CUP method can be reliably applied on the facts of a case, it does offer most direct method of neutralizing the impact of interrelationship between AEs on the price at which the transactions have been entered into by such AEs. 65. While traditional methods seek to compute the prices at which international transactions would normally be entered into by the associated enterprise, but for their interdependence and relationship, transactional profit methods seek to compute the profits that the tested party would normally earn on such transactions with unrelated parties. It is only axiomatic that the profits earned by an enterprise is dependent on several factors, and not only on the prices at which transactions have been entered into with the associated enterprises. The profit based results thus admit possibility of vitiation of results by a number of factors which are not relevant to the determination of pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... components from local Indian vendors, suitable adjustments can be made for the same. The method itself cannot be rejected. Hence, this issue is decided in favour of the Revenue. 40. Next issue is whether future data can be taken for the purpose of comparables. On this issue we uphold the order of the Commissioner of Income-tax (Appeals) that the Transfer Pricing Regulations do not contemplate taking into account future data for the purpose of bench marking. Hence in respect of 7 components, the TPO's action in using future data is rightly held as not in consonance with Transfer Pricing Provisions. 41. Next issue is whether the valuation of goods accepted by the customs authority should be considered for the purpose of arriving at ALP. The valuation of goods by the customs authorities are done for the different purpose and in different context. When the imports are over-valued, the Customs Authorities are most likely do not disturb the value for the reason that, they could charge higher customs duty, whereas under Transfer Pricing Regulations, an attempt is being made to determine the arm's length price. The decision in the case of Samsung India Electronics Ltd. (supra) is in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rate in" comparison with other comparable cases cannot be considered as a licence to the assessee to record other expenses in international transactions without considering the benefit, service or facility out of such expenses at arm's length. All the transactions are to be separately viewed. Also, the contention fails if any of the other methods (CUP etc) are adopted instead of TNMM" (See Paras 21.3 to 21.8 of the special bench order). 42.2 This being a binding precedent as well as the correct position of law on the plain reading of the Section and Rules, we uphold the finding of the TPO that TNMM is not the most appropriate method in the case on hand. 43. The learned counsel for the assessee relied on the decision of Hon'ble Delhi High Court in the case of Maruti Suzuki India Ltd. (supra). At Para 65, the Hon'ble High Court held as follows:- "65……………… The correct approach to determine the fair price of such parts and components would be either to ascertain the price at which such components and parts were being exported by Suzuki outside Japan or the price at which they were being sold in Suzuki's domestic market. The other alternativ ..... X X X X Extracts X X X X X X X X Extracts X X X X
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