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TMI Blog2014 (5) TMI 734X X X X Extracts X X X X X X X X Extracts X X X X ..... rage re-structuring of legitimate business transactions - The reason for characterization of re-structuring as an arbitrary exercise is that it has the potential to create double taxation if the other tax administration does not share the same view as to how the transaction should be structured. It is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity - It is also not necessary to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years - The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more - the assessee company maintained the necessary documentation of the international transactions as per Section 92D read with Rule 10D - The assessee company had also submitted details of the technology knowhow it obtained from its AE and the details of the Royalty payments made - The TPO has not only refuted the justification of Royalty payments but also pointed out that there was "reverse flow" by analyzing t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO) u/s.92CA(l) of the Act. In response to this, after making necessary verification in the matter, the TPO noted that various international transactions made by the assessee with the AE, as reported in the audit report in Form No.3CB are at arm's length, except the International transactions pertaining to royalty paid to the AE, which was not reflected In the said Form No.3CB report. 2.1 The TPO noted that the assessee company which was incorporated In 1992, is engaged in undertaking design, manufacturing, marketing and sale of air and gas separation equipments/plants. He further noted that the assessee undertakes the function of delivering the products to the AEs. During the proceedings before him, the assessee has furnished a copy of Transfer of Technical know-how agreement with M/s. Air Liquid, France, as per which, in respect of all products the royalty will be at 5% for domestic sales and at 8% for exports. He noted that during the previous year the assessee has paid royalty of Rs.l,42,84,061/- to the AE on account of sale made to unrelated party through the AE. The said amount is debited to the profit and loss account. During the transfer pricing proceedings the TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... year the assessee company manufactured and sold certain goods to independent third parties and its associated enterprise. Objecting to such disallowance made by the TPO, after observing that permanent establishment in India of a non-resident company cannot pay any royalty to the parent company, it was submitted that, it is nowhere specified in the Act that royalty payment by branch office to the parent company is to be disallowed. It was further submitted that during subject assessment year' the royalty paid by the assessee is with respect to sales to independent third parties. It was stated that the TPO has wrongly observed that those sales have been made to the third parties though the AEs of the assessee. 3.2 It was submitted that royalty is being paid by the assessee to Air Liquide, France, as a consideration for right to use the technical know-how which is provided to it by the said company. Such right has been granted by that company to the assessee to design, engineer, procure, construct manufacture, erect, commission and sale the products as defined in the agreement entered into with the company. Referring to Articles 3, 4, 5 of the said agreement, it was submitte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring the previous year, during the assessment proceedings. Under such circumstances, even though the assessee has contended that it has made sales only to Independent third parties, such claim is not verifiable. However, it may be mentioned when the assessee has earlier stated that the company in their case and the AE are to be treated as independent entities, so far as the sales are concerned, it shows the assessee admits that some sales were made by them to the AE during the previous year under consideration. Further, from the statement of royalty payment furnished by the assessee before the A.O. during the assessment proceedings, as available in the assessment record, though it is seen that the assessee has raised those Invoices towards royalty payable to the AE, in respect of different projects, it is not known as to how the same has been arrived at, further from such invoices it Is seen that the assessee has also paid royalty in respect of some foreign projects. It has also paid royalty In respect of spares for certain project. It is not known as to how royalty can be paid for supply of spares to different projects. In any case when the assessee has not furnished nor explained ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the facts and circumstances of the case and in law, the CIT(A) has erred in law and on facts, in holding the arm's length price in respect of royalty paid by Appellant to its associated enterprise to the extent of Rs 71,42,031 to be nil. 1.5 That on the facts and circumstances of the case and in law, the TPO / AO / CIT(A) has erred in observing that no royalty can be paid by an entity with respect to sales made to its associated enterprises where the entity avails technical knowhow from the said associated enterprises. 1.6 That on the facts and circumstances of the case and in law, the CIT(A) has erred in observing that assessee has paid royalty with respect to supply of spares for various projects. 1.7 That on the facts and circumstances of the case and in law, the learned TPO / AO / CIT(A) has erred in disregarding the commercial agreements entered into by the appellant without any valid and cogent reasons. 1.8 That on the facts and circumstances of the case and in law, the TPO/A.O./CIT(A) has erred by acting in a arbitrary and ad-hoc manner and not followed any prescribed Transfer Pricing methodology (as required under section 92C of the Income Tax Act, 1963 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ermining ALP as 'Nil' given the fact that the assessee admitted that there was reverse flow of technology and hence there can be no usage of technical know-how of the Associated Enterprise. 6. The CIT(A) ought to have noticed that the profit margins shown by the assessee is low compared to comparable cases which justifies disallowance of Royalty in toto. 7. Any other ground that may be urged at the time of hearing the appeal. 7. At the outset, we find that the TPO in his order had concluded as follows: 17. Conclusion: From the discussion made in the foregoing paragraphs, there is no evidence with the taxpayer in support of any transfer of technology which entails payment from the taxpayer to its AE. FY 2006-07 is the 14th year of operation for the taxpayer. From FY 1999-2000 onwards, in every annual report it is mentioned that the technology is fully absorbed. There is no reason as to why the taxpayer should pay royalty in perpetually in the guise of technical services received. Documentation available on record reveal that the taxpayer has grown into a full blown technology company which is rendering technical services to it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cost or below cost. The prices charged by AEs when they execute projects outside India vis- -vis prices charged per man day if their man power is deployed remained unanswered by the taxpayer. Taxpayer cannot compare the prices charged to Reliance Industries Ltd. which is located in India with the prices for the services rendered to its AEs outside India. Economies and geographies play a significant role in determining the prices of goods and services, which is not accounted for by the taxpayer. (e) When in fact the taxpayer is providing technical services to its AEs at cost or below cost, there is no need for any separate payment for technical services, which never received, in the guys of royalty. (f) The net profit margin earned by the taxpayer both on cost and on sale is significantly lower as compared to the margins earned by the independent comparables as discussed in the foregoing paragraphs. Benefits received by the taxpayer from the payments made towards technical services are not substantiated with any evidence. Also, costs incurred/contributed by its AEs in the process of transfer or technical knowhow vis- -vis payments received also remained unexplained. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 administrations 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 these are consistent with the methods described in Chapters II and III. In other than exceptional cases, the tax administration should not disregard the actual transactions or substitute other transactions for them. Restructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al 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 should not disregard the actual transaction or substitute other transactions for them and the examination of a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises. It is of further significance that the guidelines discoura ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand, (1938) 6 ITR 636 (SC) 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 or not. That is the plain requirement of proper accounting and the interpretation of Section 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income. It is noteworthy that the above observations were m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hority 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 valid reasons as to why it was suffering losses continuously and these have been referred to by us earlier .' 10. The Hon'ble Tribunal in the case of Ericsson India (P.) Ltd. v. Dy. CIT (ITANo. 5141/Del/2011), too, following the law laid down by the Hon'ble Delhi High Court, hel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expediency. Therefore, the case laws relied upon by the learned CIT-Departmental Representative are of no benefit to the Revenue. The reasonableness of expenditure in the present circumstances and facts of case cannot be doubted and accordingly the AO is directed to allow the claim of the assessee and the order of learned CIT(A) is reversed. Thus, ground no. 3 of the assessee is allowed. 14. In the case of SC Enviro Agro India Ltd. v. Dy. CIT (ITA No 2057 2058/Mum/2009) the Hon'ble Mumbai Bench of the Tribunal held that The TPO has to examine whether the price paid or amount paid was at arms length or not under the provisions of Transfer Pricing and its rules. The rule does not authorize the TPO to disallow any expenditure on the ground that it was not necessary or prudent for assessee to have incurred the same 15. Further, the Hon'ble Delhi Bench of the Tribunal in the case of AWB India (P.) Ltd. v. Addl. CIT ITA No 4454/Del/2011 held as under: As also settled by judicial decisions (supra), the revenue authorities are not empowered to question the commercial wisdom of the assessee and it is entirely for the assessee to take such ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the absence of production and sale of products, there would be no question arising regarding payment of any royalty. Rule 10A(d) of the ITAT Rules defines 'transaction' as a number of closely linked transactions. Royalty, then, is a transaction closely linked with production and sales. It cannot be segregated from these activities of an enterprise, being embedded therein. That being so, royalty cannot be considered and examined in isolation on a standalone basis. Royalty is to be calculated on a specified agreed basis, on determining the net sales which, in the present case, are required to be determined after excluding the amounts of standard bought out components, etc., since such net sales do not stand recorded by the assessee in its books of account. Therefore, it is our considered opinion that the assessee was correct in employing an overall TNMM for examining the royalty. The TPO worked out the difference in the PLI of the outside party (the assessee) at 4.09% and the comparables at 7.05%. This has not been shown to fall outside the permissible range. 34. The decision of the Tribunal in 'Ekla Appliances', 2012-TII-01-HCDel- TP, has been sought t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the addition made by the TPO and upheld by the DRP is unsustainable and is to be deleted. Hence Ground No. 2 is held in favour of the assessee. Hence, the appeal of the Revenue ITA.No.1040/Hyd/2011 is dismissed and Assessee's appeal in ITA.No.1159/Hyd/2011 is allowed. 22. With respect to ITA.No.1408/Hyd/2010 for the A.Y. 2006-2007 the facts are identical and hence the conclusions drawn in ITA.No.1159/Hyd/2011 have to be applied. Further, the learned Counsel for the assessee had also invited our attention to page 53 wherein the operating cost has been declared at Rs.98,61,88,320/- and the same has been reflected in the P L account for the year ending 31st March, 2005 at page 234 of the paper book. At page 245 of the paper book under 'Selling Expenses' the amount of Rs.2,02,94,565/-against royalty has already been taken into account. Hence, we find that royalty has been already considered and factored in and hence, the Assessing Officer's order has to be dismissed as unjustified. Since, we find force in the arguments of the learned Counsel, we allow the appeal of the assessee ITA.No.1408/Hyd/2010. 23. In the result, ITA.No.1040/Hyd/2011 of the Revenue is dismi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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