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TMI Blog2013 (11) TMI 668X X X X Extracts X X X X X X X X Extracts X X X X ..... tributed, it has to be so done evenly. TPO attributed the difference is ALP of cost entirely to the purchase of components made by the assessee from its Associate Enterprise which, in our opinion, will not give fair results. Adjustment that can be carried out at the best is only on the proportionate sale that are relatable to the components imported by the assessee from its Associate Enterprise and not on the whole of the operational income - the issue of determining the arm's length price with respect to the imported components from Associate Enterprise requires a fresh look by the Assessing Officer - Decided in favour of assessee. Capital or revenue expenses - Disallowance of royalty - Whether the assessee has acquired a right to use the 'technology and licence' during the assessment years - Held that:- From the perusal of the agreement it is found that KMC granted the assessee an exclusive right to manufacture and sell the products in India using the licenced technology provided. An exclusive right has been conferred on the assessee for manufacturing and selling the products in India - it is a case where royalty was paid initially and also running expenses towards royalty are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d third one is on a disallowance under Section 14A of Income-tax Act, 1961 (in short 'the Act'). 2. Issue relating to adjustments made to arm's length price is considered first. 3. Facts apropos are that assessee is a joint venture between Lucas-TVS Limited, Chennai and Koito Manufacturing Company Limited, Japan. It is engaged in manufacture of headlamps, rear combination lamps and other lamps for automotive applications. Assessee had entered into international transactions with its Associate Enterprises in Japan for import of components, import of capital asset, payment of royalty, design and drawing fee. For justifying the costs, assessee had used Transaction Net Margin Method (TNMM) using its operating margin to total cost as Profit Level Indicator (PLI). 4. Assessing Officer, during the course of assessment, made a reference to Transfer Pricing Officer (TPO) under Section 92CA(1) of the Act for determination of arm's length price on the transactions recorded by the assessee in Form No.3CEB filed by it along with its return. A perusal of the order dated 29.10.2009 of TPO clearly brings out that an adjustment was recommended only in respect of cost of components imported by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, viz. incremental cost towards recruitment of additional people in the Research Development Department. DRP was of the opinion that such augmentation of the R D was a normal business strategy and there was nothing extraordinary, requiring an adjustment on the ALP. Assessee also raised a grievance that plus / minus 5% range allowed was not given to it. However, this view was not accepted by the DRP, considering the amendments made to Section 92C of the Act by Finance (No.2) Act of 2009 with effect from 1.10.2009. The draft assessment order having been framed on 30th December, 2010, as per the DRP, the TPO was justified in not giving the benefit of plus or minus 5%, since the arm's length price for the components imported by the assessee fell above such limits. Considering the DRP recommendations, assessment was finally completed, carrying out the adjustments required by the TPO on the prices paid by the assessee for the components purchased by it, from its Associate Enterprise. 6. Now before us, learned A.R., strongly assailing the order of TPO, at the outset, submitted that various figures given by the TPO while working out the arm's length price, reproduced at para 4 above, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submitted that what was worked out by the TPO was the arm's length price of the raw material purchased by the assessee from its AE. The arm's length price was worked out first by finding the arm's length cost of the assessee. For arriving at the cost attributable to the transactions with non-AEs, the TPO had correctly reduced from the total operating cost, the actual cost of the raw materials purchased by the assessee from its Associate Enterprise. The resulting figure was the actual operating cost less cost of raw material imported from the Associate Enterprise. When this sum was deducted from the arm's length cost, what would result is the arm's length price of the imported components. Therefore, according to him, the analysis made was correct and excess of Rs. 0.79 Crores paid by the assessee had to be adjusted by making a downward reduction of such amount from the total cost. Such amount Rs. 0.79 Crores exceeded 5% of the actual cost of components imported from Associate Enterprise, which came to Rs. 13.19 Crores. Therefore, assessee could not claim any benefit under second proviso to Section 92C(2) of the Act. 8. We have perused the orders and heard the rival submissions. Fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 265.83 Crores and operating cost was 251.04 Crores. The figures were rightly considered for working out the PLI of the assessee and its comparables after excluding those items which did not fall within operating expenses or operating income. Such exclusions were confirmed by the DRP and assessee is also not agitated by such exclusion before us. While computing the arithmetic mean of the PLIs of the two comparables, no doubt, the operating margin of M/s Halonix Ltd. has been taken as 12.93%. The operating margin even going by the figures given by the Assessing Officer was only 12.23% and not 12.73%. This is a sheer arithmetic mistake. When 12.23% is considered, the arithmetic mean of PLI comes to 10.17%. This error no doubt has to be rectified. For better understanding, the determination of ALP done by the TPO, we are re-formatting his work-out without substituting the corrected PLI, upto the level of arriving at the operating costs hereunder:- Operating income of assessee-company 265.83 Crores Operating cost of assessee-company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t give any meaningful figure at all. What has to be deducted from total cost is not only the material cost pertaining to purchase from AEs but also that part of other expenses attributable to such purchase which have a bearing on total operating margins. In other words, Assessing Officer divided the total operating cost between material cost relatable to AEs and cost relatable to non-AEs, which included both material cost as well as other costs. Thus the ALP cost arrived at by TPO was not logical. He deducted from the operating cost, only the material cost relatable to purchases from AEs and not the operating cost attributable to such material cost. The resultant figure will not give ALP of the purchases made from AEs. If along with the material cost paid to AEs, operational cost attributable to such cost was also considered, then the sum of Rs. 2.57 Crores considered by the TPO as ALP of AE purchases, would have gone up significantly. In our opinion, therefore, the work out of ALP of the purchases from non-AEs has been erroneously done. The difference of Rs. 13.18 Crores arrived at is hypothetical. If at all raw material was deducted, other costs excluding the total raw material c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... me up before this Tribunal in appeals for preceding assessment years 2004-05 to 2006-07 in I.T.A. Nos.676 to 678/Mds/2010. As per learned A.R., on similar fact situation, it was held by this Tribunal that expenses debited towards royalty payments were to be treated as revenue payment in toto. Learned D.R. fairly agreed that the issue was covered in favour of assessee by the above mentioned co-ordinate Bench of this Tribunal. 12. We have perused the orders and heard the rival submissions. The question raised is regarding payment of royalty to Koito Manufacturing Ltd., Japan. Whether such royalty paid could be allowed in full as revenue expenditure or whether it had to be considered as a capital outgo, was an issue before this Tribunal in assessee's appeals for assessment years 2004-05 to 2006-07. It was held by this Tribunal at paras 3 to 6 of its order dated 10th June, 2011, as under:- "3. We have considered the rival submissions and have perused the entire relevant provisions of law and precedents applicable thereto and relied before us. It was argued on behalf of the assessee that in assessment year 2003-04, the Department has itself accepted this expenditure as revenue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as been paying royalty @ 3.5% for products manufactured by using licenced technology supplied by KMC This royalty is paid @ 3.5% of net sales less imported components. As per this agreement, if there is no sales, no royalty is payable by the assessee. 5. We have gone through various Articles of this agreement which are incorporated in the appellate order for assessment year 2005-06 towards which our attention was also invited. The Assessing Officer has relied on the decision of Hon'ble Madras High Court rendered in the case of CIT v. Southern Switchgear , 148 ITR 272, affirmed by the Hon'ble Supreme Court in 232 ITR 359, to hold that the entire royalty paid has to be treated as capital. But we have noticed that the facts of this case are slightly different and the Hon'ble Madras High Court has held in numerous other decisions that mere grant of exclusive right to manufacture may not result in acquiring any capital asset. In this regard, decision of Hon'ble Madras High Court in the case of CIT v. Lucas TVS Ltd., 110 ITR 338 which has been confirmed by the Apex Court by dismissing the SLP of the Revenue, 196 ITR 78 (Statute); CIT v. Sundaram Clayton, 136 ITR 350 (Mds); CIT v. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f them. The treatment given by the ld. CIT(A) to 25% of the expenses towards royalty payment, as capital and thereafter allowing depreciation thereon, is not correct approach in our opinion. Recently, the Hon'ble Madras High Court in the case of CIT v. Panasonic Carbon India Company Ltd., vide its judgment dated 12.7.2010 in Tax case Appeal Nos.552, 553, 554 and 556 of 2010, has taken a decision in favour of the assessee after discussing the judgment of Hon'ble Supreme Court rendered in the case of CIT v. IAEC Pumps Ltd (supra). In that case, the technical know-how for setting up the factory of the assessee-company and commencing its production was provided by MEI [a foreign company] in consideration of a lump sum payment to MEI which was capitalized in the assessee's books of account in respective years of payment. The royalty was paid by the assessee from June 1984 onwards based on the sales effected at the rate of 2.5% on domestic sales and at 5% on exports. The court was deciding whether such royalty payment would fall within the category of revenue expenditure or capital expenditure. The High Court has taken a view in favour of the assessee. The Chennai Bench, recently in the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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