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TMI Blog2015 (1) TMI 921X X X X Extracts X X X X X X X X Extracts X X X X ..... that need not be strictly based on specified transfer pricing methods. Therefore, in such a situation, the perfect approach for indirectly bench marking royalty payments is to bench mark the profit margin left in the tested party, after payment of lump sum fee or royalty with the profit margins of comparable uncontrolled companies. Therefore, we are of the opinion that even if the royalty payment is to be analyzed separately, TNMM is the most appropriate method for determining the ALP. The fact that the assessee was engaged in the activity of manufacture itself proves the use of technical know-how by the assessee and therefore, as held by the Hon’ble Delhi High Court in the case of EKL Appliances (cited supra), the AO or the TPO cannot question the commercial expediency of the assessee or the quantum of benefit the assessee derived while making the payment. We agree with this contention of the assessee. Remand the issue for determining the ALP under the TNMM, the assessee as well as the Revenue have to search for comparable companies. Therefore, we remit this issue to the file of the AO/TPO to determine ALP of royalty by adopting TNMM after giving the assessee a fair opportunity o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... established in the year 2002 for the manufacturing of automatic front axle, rear axle and the propeller shaft. During the financial year ending 31/03/2008, the assessee entered into various international transactions with its Associated Enterprises (AEs). One of the international transactions entered into with its AEs includes payment of royalty for using the technology and technical know-how. The assessee aggregated all the international transactions and adopted TNMM as the most appropriate method and arrived at the operating margin on sale at 9.87%. The AO accepted all the international transactions of the assessee with its AEs to be at arms length except the payment of royalty. He treated the payment of royalty to be a separate kind of transaction and held that TNMM is not the most appropriate method for determination of the ALP. He adopted the CUP method and also applied the benefit test and arrived at the ALP of the royalty payment at 'nil'. The assessee had also filed a comparability analysis as per CUT method but the same was not accepted by the TPO and treated the royalty at 'nil'. Accordingly, the transfer pricing adjustment was made and the entire payment of royalty was b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ption of the International Transaction INR in 000's Benchmarking Methodology Purchase of raw materials, components and consumables 6,60,217 Transactional Net Margin Method (TNMM) Purchase of Capital Assets 75,944 Payment of royalty 2,72,309 Payment for technical assistance 18,828 Payment of IT support fee 4,905 Payment of warranty claims 19,311 Payment of training fees 5,087 Payment towards reimbursement of expenses 5,032 Sales Return 286 The AO observed that these transactions are purchase of raw materials, components and consumables which are used in manufacturing of the rear axles, front axles and the propeller shafts for the multi utility vehicles manufactured by Toyoto Kirloskar Motor Pvt. Ltd., and the expenses are towards related and connected processes of manufacture. The AO further observed that the assessee had also paid royalty, technical assistance fee, engineering fee and information technology support fee to the associated enterprise for the purpose of manufacturing the above said motor parts. Since the assessee's transactions were international transactions, the Assessing Officer referred the matter of determining the Arm's Length Price (ALP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the profits earned using such technology. He further observed that even after paying such huge amounts as royalty, the assessee's margin is only 6.71% on sales, which is lesser than the average margin of 8.29% of the comparable companies (who are not paying similar royalty payments and also do not have significant intangibles) considered by the TPO. Thus, he came to the conclusion that the assessee did not get any tangible commercial benefit in terms of improved profitability even after paying for technology know-how and the payments are only to siphon off the profits from India with minimum incidence of tax. He also considered the reasonableness of the royalty paid by the assessee and held that it is not proved. He, therefore, determined the ALP of the royalty payment at 'Nil' and made the adjustment of ₹ 27,23,09,000/- u/s 92CA of the Act. Pursuant to the order of the TPO, the AO proposed a draft assessment order and called for objections, if any, of the assessee to the said draft assessment order. The assessee filed its objections before the DRP and the DRP confirmed the draft assessment order. 5. Consequent thereto, the Assessing Officer passed the final assessment orde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO has to conduct comparability analysis, which is an essential element of TP analysis and for failure to do so, the TP adjustment cannot be substantiated. 8. As regards the adoption of the TNMM method for the aggregation of the transactions, he submitted that the payments of royalty and technical services are under the same technical agreement and therefore different approach cannot be adopted for these two transactions without giving any valid reasons for doing so. He submitted that the technical services have been aggregated with the other international transactions while different approach has been adopted for determination of ALP for royalty. He further drew our attention to the fact that the TPO has himself aggregated all the international transactions of the assessee during the previous assessment years i.e. assessment years 2004-05 and 2005-06 and 2006-07 including royalty payments to determine the ALP. He further submitted that if the transactions are interlinked, aggregation of the transactions is accepted both in India and internationally and on aggregation, the ALP of international transactions can be determined under TNMM if the other methods cannot be adopted reliab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ature of the royalty transactions, the TPO has rightly held that 'payment of royalty' requires separate analysis and has rightly adopted CUP method. As regards the assessee's contention that the TPO, having held that the CUP is the most appropriate method, ought to have conducted the search for comparables and, therefore, determined the ALP, he submitted that if the same is to be accepted, then the matter should be remanded back to the authorities below for determination of the ALP under CUP method. 11. Having heard both the parties and having considered their rival contentions and the material on record, we find that the following questions arise for our consideration. 1) Whether the payment of royalty is interlinked and interconnected with the other international transactions of the assessee with its AE's? 2) Where different international transactions with the AE are interconnected and interlinked, whether the aggregation of the transactions is required and the comparables are also be considered on aggregate basis. 3) Whether the TPO can apply the 'benefit test' to determine the arm's length/price of the transaction. 4) Whether CUP is the most appropriate method in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... available at the transaction level. In such circumstances, entity level information is the only recourse available. Therefore, whether ALP-principle is to be applied on a transaction by transaction basis or on an aggregation basis depends on the facts of each case and is not universally or generally applied in all composite contracts involving multiple transactions. 14. In the case before us, the assessee has entered into various transactions which include purchase of raw-material, components and consumables, capital assets and payment towards royalty, technical assistance, IT support fee, payment of warranty claims, training fee, reimbursement of expenses etc. It is the case of the assessee that all these transactions are inter-linked. However, on perusal of the TP documents filed along- with return of income, we find that the payment of royalty is not part of a composite contract/agreement but is on account of a separate Technical Assistance Agreement entered into by the assessee with its AE. The assessee is required to pay the royalty under the Technical Assistance Agreement for use of certain Technical and manufacturing know-how proprietary to Toyota Motor Corporation/Aisin T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... because even minor differences in contracted terms or economic conditions could materially affect the amount charged in an uncontrolled transaction, Comparability under this method depends on close similarity with respect to these factors or adjustments to account for any differences. Therefore, CUP method is the most direct and reliable method for determination of ALP for the controlled transaction if an uncontrolled transaction has no differences with the controlled transactions that would affect the price or if there are only minor differences that have a definite and reasonably ascertainable effect on price and for which appropriate adjustments can be made. Per contra, Transactional Net Margin Method requires establishing comparability at a broad functional level, such as trading, manufacturing etc. Thus, TNMM requires comparison between net margins derived from the operations of the uncontrolled parties and the net margins derived by an associated enterprise from similar operations. In the case before us, the payment of royalty is for the use of technical know-how by the assessee which is owned by the AEs. The transaction thus involves transfer of intangibles. Such transfers o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... w. Therefore, we are of the opinion that even if the royalty payment is to be analyzed separately, TNMM is the most appropriate method for determining the ALP. 16. To demonstrate that the price paid by the assessee towards royalty is at arm's length, the assessee has filed copies of the agreement of the AE with its other group companies as well where the rates of royalty are the same. Thus, according to the learned counsel for the assessee, the payment is at arm's length. However, we find that even by adopting the CUP method, the AO has not brought on record any of the comparable companies to arrive at the ALP but has only applied the benefit test to determine the ALP at 'nil'. The learned counsel for the assessee had stated that the very fact that the assessee has manufactured vehicles using the technical know-how of the AE demonstrates that the assessee has benefitted from the use of such technology. He submitted that the finding of the AO that the assessee has not been able to establish the benefit derived by it from the use of technical knowhow is preposterous as the technical know-how was the essence or the heart of the manufacturing process. The fact that the assessee was en ..... X X X X Extracts X X X X X X X X Extracts X X X X
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