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TMI Blog2014 (6) TMI 317X X X X Extracts X X X X X X X X Extracts X X X X ..... LTD [2012 (4) TMI 346 - DELHI HIGH COURT] - the payment of running royalty is on revenue account - the Royalty was being paid from 1997 and was continuously examined by the AO, then in the absence of any new facts to hold that there was no need to pay the royalty was uncalled for – Decided against Revenue. Disallowance made u/s 40A(2)(b) of the Act – Held that:- As decided in assessee’s own case for the earlier assessment year, it has been held that, various facilities such as rent, electricity, water, generator expenses and also providing manpower etc. A.O. made his own estimates and held the expenditure to excessive & unreasonable - The availing of facilities is not in dispute - this issue was decided in favor of the assessee holding that there was no excessiveness or unreasonableness qua this expenditure – there was no infirmity in the order of CIT (A) that AO has not brought any cogent material on record to come to a conclusion that this expenditure is excessive or unreasonable – Decided against Revenue. - ITA Nos. 3287/Del/2011 & 5546/Del/2012 - - - Dated:- 6-5-2014 - Shri R. P. Tolani And Shri B. C. Meena,JJ. For the Appellant : Shri Yogesh Kr. Verma CIT (DR) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... L undertakes no R D activities and owns no intangible assets of its own. Besides, the assessee and Keihin Japan also entered into a Technical Collaboration agreement dated 12th September, 1997 licensing the assessee to manufacture products using the technology, know-how and technical assistance of the AE. 2.1. The Keihin Group globally, is engaged in the manufacture of fuel injection and air conditioning systems and higher value-added products by fusing higher mechanical and electronic devices. The Group undertakes major R D activities for the development of new product technologies and enhancement of existing products, this leads to creation of significant intangibles. The basic policy for the R D activities of the Keihin Group is claimed to be to support the core needs of automobile manufacturing industry. Honda Motors Co. Ltd. (Japan) owns 41.33% of the equity of Keihin Japan as well as 99.99% of the equity in Honda Siel Company India (HSCI). Both KPL and HSCI are Indian companies. 2.2. For AY 2004-05 assessee filed its return of income declaring a taxable income of Rs.4,55,33,164/- along with TP report, which was processed u/s.143(1) on 11.3.2005 and thereafter a notice ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons and oral arguments on behalf of the appellant. I find that the TPO has correctly adopted the approach about PL1 of the assessee by rejecting the operating profit to capital employed as an acceptable PLI and has correctly applied PLI of operating profit to total cost. However, I do not agree with the TPO s finding that the assessee is only a contract manufacturer. As per the FAR analysis carried out by the appellant and as also the functions performed by the assessee, which have been recorded by the TPO and not disputed by him in his order and also In view of the agreements, wherein the assessee has a license to manufacturer certain items by using the technology of its AE, I am of the considered opinion that the appellant is carrying all the normal functions of a routine license manufacturer and not a contract manufacturer. It carries all the risks of a license manufacturer. It deals with its buyer on principle to principle basis. It has received no technology, financial or any other support from its buyer HSCI, which could possibly lead to such an inference. It is observed that as per transfer pricing study, the appellant performed various functions, such as procurement a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... categorized as a routine license manufacturer, which carries out all functions of manufacturing. In my opinion, this controversy between contract manufacturer and license manufacturer has been unnecessarily given too much importance by the TPO. All auto ancillaries who manufacture components for OEM (Original Equipment Manufacturers) of cars and two wheelers etc. do so based on technology licensed to them from third parties and/or self acquired. They all negotiate prices with OEMs. The comparables used by the assessee and accepted by TPO for carrying out FAR analysis and for making adjustment to arm s length price which forms the foundation of the TPO s order are all component manufacturers for OEMs like the assessee. While retaining the comparables, the TPO has not made any distinction between full-fledged manufacturer, contract manufacturer or licensed manufacturer. Once the PLI is accepted to be operating profit to total costs as against Operating profit to capital employed it becomes irrelevant what type of manufacturing activities are carried out by the appellant. Therefore, in my opinion, even though I have held the assessee to be a routine license manufacturer, this aspec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons for arriving at reliable Arm s Length Price in respect of the International Transaction. Further, Para 1.49 to Para 1.51 of OECD Guidelines have acknowledged the use of multiple year data under special circumstances. Use of multiple year data is considered useful to smooth out the fluctuations caused by business/ economic/ product life cycle. In other words multiple year data should be used only when it adds value to the transfer pricing analysis. The issue relating to use of current year data is well settled now in view of the decision of the Special Bench of Bangalore Tribunal in the case of Aztec Software Technology Services Ltd. Vs. ACIT, (2007) 107 ITD 141 (Bangalore) and reaffirmed by the jurisdictional Delhi Tribunal in the case of Mentor Graphic Pvt. Ltd. Vs. DCIT, (2007) 109 ITD 101 (Delhi). Therefore, unless specific reasons are brought on record, which in this case the assessee has not brought on record, the comparability analysis is to be conducted on the basis of current year data. In view of the above, I am of the considered view that the relevant data of current financial year i.e. 2003 04 is to be used for benchmarking the international transactions of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ical Know how Fee Rs.41,97,000 Rs.15,90,66,935 4.1. The Arm s Length Price (ALP) of the international transactions of the appellant was properly worked out by assessee in its Transfer Pricing Study by aggregating them under the TNMM - entity level analysis using PLI as OP/CE (operating profit to capital employed) and three years average data for comparable companies. TP study was compiled by an independent consultant i.e. PWC which is based on Industries Overview and had analysis of functional test, assets employed and risk assumed by the assessee (FAR) as well as six comparables as were found through a detailed search process by using Prowess and captive Database. 4.2. It is pleaded that learned TPO has observed that average PLI of the comparables based on last three years data was 25%, whereas that of the assessee was computed at 29%. This observation gives a fair indication that all the international transactions were on the arm s length principles. Nevertheless the PLI of operating profit to capital employed was not accepted by the TPO as the correct PLI. While approving the TNMM as most appropriate method, TPO re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of royalty of Rs.1,24,41,118/-. However, since the overall difference of Rs.1,29,70,076/- has been found out towards adjustment of ALP based on the TNMM method, the TPO was of the view that this amount of royalty of Rs.1,24,41,118/- can be considered to include in the overall cost adjustment advised by him at Rs.1,29,70,076/-. 4.5. Before ld CIT(A) assessee explained that even if the revised PLI of operating profit to total cost was to be retained and even if the single year data was to be adopted, then the PLI of the assessee came to 6.22% as against 8.29% of the comparables fell very much within the permissible +/- 5% range as provided by the proviso to section 92C. The approach of the TPO to disregard this submission and to conclude that whole of the variation in earning of PLI is attributable only to the related party cost is grossly erroneous and not in conformity with provisions of TP Regulations. It was submitted before ld. CIT(A) that if the sales to associated enterprises are to be treated as sales to self as opined by the TPO, then the whole mechanism of TP provisions would fail. Thus, such a view adopted by the TPO is not in consonance with the provisions of settled ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w, as has been interpreted by various judicial bodies. 4.8. Ld. CIT(Appeal) deleted the additions by detailed observations. Gist thereof is as under: (i) PLI issue:- In my opinion, this controversy between contract manufacturer and license manufacture has been unnecessarily given by the TPO. All auto ancillaries who manufacture components for OIM (Original equipment Manufacturers) of cars and two wheelers etc. do so based on technology licensed to them from third parties and/ or self acquired. They all negotiate prices with OEMs. The comparables used by the assessee and accepted by TPO for carrying out FAR analysis and for making adjustment to arm s length price which forms the foundation of the TPO s order are all component manufacturers for OEMs like the assessee. While retaining the comparables, the TPO has not made any distinction between full fledged to be operating profit to total costs as against operating profit to capital employed it becomes irrelevant what type of manufacturing activities are carried out by the appellant. Therefore, in my opinion, even though I have held the assessee to be a routine license manufacturer, this aspect is irrelevant for purposes of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... penditure all along since 1997. It is incorrect to say that in 2003-04 it was not required; therefore should be taken at Nil, the necessity of the business of the assessee is the assessee s domain and requires no adjudication from the AO/TPO, the same has been held in a number of judgments as below: (a) Sony India (P) Ltd. V. DCIT (Delhi)(2008) 114 ITD 448 (ITAT) (b) Sassoon J. Davis Co. Pvt. Ltd. Vs. CIT [118 ITR 261(SC); (c) CIT Vs. Chandulal Keshav Lal Co. [138 ITR 601] (d) CIT Vs. Walchand Co. Pvt. Ltd. [65 ITR 381(SC);] (e) J.K. Woollen Manufacturing Vs. CIT [72 ITR 612 (SC)] (f) Aluminium Corp. of India vs. CIT [86 ITR 11 (SC)] and (g) CIT Vs. Panipat Woollen Cement Mills [103 ITR (SC)]. 4.10. Ms. Pallavi Dinodia, ld. Counsel for assessee fairly conceded that assessee has no objection to the action of the TPO, which is confirmed by ld. CIT(A) regarding the adoption of PLI of operating profit to total cost (OP/TC) as also the adoption of single year data in accordance with rule 10B(4) of the I.T. Rules. 4.11. However, with regard to issue of treating the assessee as contract manufacturer by the TPO learned CIT(A) has categorically held that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Revenue. 4.13. Reliance is placed upon the para 16 of the ITAT judgment in the case of Samsung India Electronics Pvt. Ltd., vs. ACIT in ITA No. 5316/DEL/2011 dated 21.6.2013 (one of us is a party to it), in similar circumstances corporate veil can only be looked at and not looked through . Similar view has been echoed by the judgment of Hon ble Supreme court in the case of Vodafone reported as 341 ITR 1 (SC), wherein similar proposition about multi entity corporation has been considered. It has been unambiguously held that legally incorporated entities retain their separate existence and corporate veil can not be attempted to be lifted in a casual manner. 4.14. Apropos TPO action to deny benefit of proviso to section 92C for +/- 5% it is stated that TPO had erroneously held that if there is difference in the PLI of the tested party with that of comparable, then the difference is inherently presumed to be pertaining to international transaction. Such a view has no support of any rules, regulations or provisions of the transfer pricing. On the contrary, it was obligatory on TPO to correctly apply the provisions of the transfer pricing and ought to have restricted the adju ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nnot determine the price at Nil unless he applies one of the specified methods as per law or rules. For this proposition reliance is placed upon the following case laws: - (i) That unless one of the 5 methods prescribed u/s 92C of the Act are applied by the TPO to determine the ALP of international transactions including that of Royalty, the same cannot be determined at NIL. The same has also been held in the case of Castrol India vs. Addl. Commissioner of Income Tax, [2014-TII-08-ITAT-Mumbai TP] and CA Computer Associates vs. DCIT [2010-TIOL-68-ITATMUM]. (ii) Air Liquide Engineering India Pvt Ltd. [TS-43-ITAT-2014- Hyderabad-TP], wherein it was held that once the payment of royalty @5% on domestic sales and 8 % on export sales is based on a RBI approval then the same is deemed to be transacted arm s length price. i. DCIT vs. Sona Okegawa Precision Forgings Limited [TS- 773-ITAT-2011(Del)-TP] ii. Hero Motorcorp Limited vs. Addl CIT [TS-718-ITAT- 2012(Del)-TP] iii. Thyssen Krupp Industries India Pvt. Ltd. [2013-TII-13- ITAT-Mumbai-TP.] iv. Abhishek Auto Industries Ltd. vs. CIT [TS-60-ITAT- 2010(Del)-TP] 4.17. Hon ble Delhi High court in assessee s own case for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... corporate veil has no justification. 5.2. This view is supported by judgment of co-ordinate Bench of the ITAT in the case of Samsung (supra) wherein the Tribunal at page 27 has held that:- 6.9 Thus, we agree with the ld. Counsel of the assessee that TPO has confused the issue by noting that the payment of royalty is to itself i.e., holding company .In this regard, it has been submitted that TPO at page127, para7.2 has observed that all the AE s typically are within the broad umbrella of the multinational corporation . It has been rightly submitted by the ld. Counsel of the assessee that that while doing so TPO endeavoured to reach the so called economic substance ignoring the legal substance accepted and admitted in separate jurisdictions. In such a situation the veil has only to be looked at and not looked through. 5.3. This view is further fortified by Hon ble supreme court judgment in the case of Vodafone (supra). 5.4. Ld. CIT(A) page 49 of the order has categorically held that unnecessary importance has been given by the TPO whether the assessee is a contract manufacturer or a licensed manufacturer. This is for the reason that all the comparables taken by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Adjustment on international transactions (D) * (E) 3,033,593 5% of International transactions (5% of B) 7,953,347 1.3 The above computation shows that the International transactions of the assessee falls within the +/- 5% range as per proviso to Section 92C (2). We agree with this view of the appellant and approve the same and hold that TPO was not correct in adopting a view that whole of adjustment is to be presumed as arriving out of international transactions. There is no law for making such presumption 1.4 The appellant submitted that as per the Order of the TPO in calculating the quantum of adjustment he has correctly brought out that the OP/TC calculation is impacted by Operating income and Total Cost. The International transactions of the assessee also forms part of the total cost and constitute 23% of the total cost. A shortfall in operating profit could arise on account of a shortfall in operating income, higher third party costs or higher international transactions. In doing so the TPO has erroneously presumed that the entire shortfall is only on account of the higher international transacti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e tax clearly indicates that the company has no intention of shifting profits in India or evading taxes as such. 5.6. The learned CIT(A) has accepted this proposition of the assessee restricted the calculation of the adjustment at 23% to the total cost . The learned DR has not controverted this proposition. Therefore, following the catena of ITAT judgments, we hold that CIT(A) was correct in confining the calculation of adjustment to the international transactions only and not on the entire total cost of the entity. 5.7. Secondly ld CIT(A) held that the assessee falls within the plus minus 5% range under proviso to section 92C(2) of the Act is concerned,; Significantly both the TPO and the learned AO in principle have raised no objection to this safe harbor provision in principle. The TPO has, however, made his own calculation and has come to the conclusion that the arm s length price is beyond the plus minus 5% range. Ld CIT(A) has dislodged TPO s calculation, which has not been effectively controverted by the department, consequently safe harbor rules becomes clearly applicable to assessee s case. Decision for AY 2004-05 T P adjustments: 5.8. We have considered the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cessity of paying the royalty which is to be decided from businessman point of view. This proposition has been upheld by the Hon ble Delhi High Court in the case of CIT v. EKL Appliances 2012-TII-01-HCDel- TP. The accepted history of the case regarding Payment of Royalty is that in assessment year 2003-04 also the matter travelled up to the Delhi High Court. It is held in favour of the assessee that the payment of running royalty is on revenue account. Therefore, in view of the Hon ble Delhi High Court judgment in assessee s own case the necessity of payment of royalty cannot be questioned or doubted. 5.12. Besides similar issue of royalty payment is decided in favor of the assessee is decided by the ITAT in the case of Lumax Industries Ltd. [2013- TII-123-ITAT-DEL-TP] holding that: Payment of royalty was being claimed and allowed right from 1984 to Assessment Year 2003-04, as business expenditure of the assessee and no new circumstance has been pointed out by either of the authorities below to hold that in the years thereafter, the benefit accrued to the assessee by the payment of such royalty has dried up; 5.13. Our aforesaid view is fortified by the aforesaid judgment ..... X X X X Extracts X X X X X X X X Extracts X X X X
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