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TMI Blog2012 (11) TMI 1107X X X X Extracts X X X X X X X X Extracts X X X X ..... manufacturing of household insecticides and pesticides in crop protection field. As part of the license the technology and intellectual property and production of chrysanthemic chloride and d-Allethrin were granted to assessee. In the year 2000-01 the SCCL Japan acquired 90% of the equity share capital of the company and the name was changed. The Company is primarily engaged in the manufacture of insecticides and pesticides. As per the agreement the company has to sell its products only to the parties approved by the said SCCL. It also purchases the requirement of intermediates from the said company only. In the impugned two years assessee has purchased intermediates and sold the products to the entities that are expressly approved by the said SCCL. One of the company to whom most of the products were sold as M/s Sumitomo Chemical India (P) Ltd (SCI) i.e. 100% subsidiary of SCCL. In the transfer pricing report assessee submitted that the arrangement with SCCL and SCI is in the nature of contract manufacturing. The transactions were referred to TPO for determining Arm length Price. While accepting the price paid/received as arm's length price for purchase of insecticides and pes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The learned Commissioner of Income Tax (Appeals) has erred in disallowing Rs. 61,25,3201- out of total royalty payment of Rs. 89,44,388/-, being royalty payment in connection with sales made to the associated enterprise by the appellants . Your appellants submit that the same is allowable and ought to have been allowed. Without prejudice to the above, it is submitted that the learned Commissioner of Income Tax (Appeals) failed to appreciate that the royalty paid by the appellants is only 5% of net ex-factory price of sale, and that as per section 92C(2), a standard deduction of 5% has to be granted from arm's length price determined by the TPO/AO. Your appellants submit that since the royalty of 5% paid comes within that range, no adjustment needs to be made. Without prejudice to the above, your appellants submit that AO/TPO has not adopted any particular method for determining arm's length price of royalty as per provisions of Section 92C the Income tax Act, 1961. Hence your appellants submit that no adjustment needs to be made. (b) Your appellants submit that the learned Commissioner of Income Tax (Appeals) erred in passing the appellate order on the erroneous presumpti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 6. The learned Counsel relied on various case law to submit that the agreement is on principal to principal basis and not a contract manufacturing arrangement. 7. It was further argued that the TPO cannot question the business purpose of transaction when assessee paid 5% royalty and restrict the same to Nil stating that assessee is a contract manufacturer. It was the submission that apart from the fact that assessee is an independent manufacturer and not a contract manufacturer, the TPO cannot disallow the entire amount under section 37(1) and relied on the principles laid down by the Hon'ble Delhi High Court in the case of CIT vs. EKL Appliances in ITA No.1068/70/2011 (Del HC) and also the ITAT decision in the case of Ericson India (P) Ltd vs. DCIT in ITA No.5141/Del/2011. It was also further contention that since royalty was paid at 5%, AO cannot disallow the entire amount as it was within the safe harbor range of (+)/(-) 5% and relied on the cases of ITAT Bangalore in the case of Philips Software Centre (P) Ltd vs. ACIT, 26 SOT 226 and ITAT Pune Bench decision in the case of Starnet Networks (India) Pvt. Ltd vs. DCIT (ITA No.1350/PN/2010) to submit that no disallowance can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of Sona Voka Precision Ltd to submit that in that case only fraction of the goods manufactured are sold to the AE, whereas bulk of the sales are sold to the uncontrolled parties. In that case it was held that assessee cannot be said to be a contract manufacturer for AE whereas in this case two-thirds of the goods manufactured are sold to AE. Therefore, assessee has to be considered as contract manufacturer. It was further submitted that the case law relied upon by assessee was not applicable as they are pertaining to the definition of 'work contract' under section 194C and does not apply to the arrangement of contract manufacturing. He also distinguished the decision of the Hon'ble Delhi High Court in the case of CIT vs. EKL Appliances (Supra) to submit that in that case assessee could not demonstrate the benefit or advantage obtained by the technical knowhow received and there was no justification for the royalty which was disallowed, whereas in this case the facts are different. It was his submission that the CIT (A) has correctly allowed the royalty payment on sales made to outside parties and disallowed the royalty payment on sales made to AE. 10. In reply it wa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll assessment year 2003-04 there was no dispute with reference to the payment of royalty and even in the original assessment completed the royalty was allowed as eligible expenditure in the order under section 143(3). In assessment year 2004-05 this issue for the first time was examined by the TPO on the basis of the TP report of assessee wherein assessee submitted that the arrangement is in the nature of contract manufacturers in the FAR analysis. Since this was admitted by assessee, the TPO without examining the nature of agreement or the manufacturing activity of assessee or any other incidental factor came to a conclusion that since assessee admitted to be a contract manufacturer, there is no need to pay any royalty. In his order the TPO also mentions that assessee was not making any sales to outside parties, the fact of which is not correct. On the basis of his observations, he arrived at the royalty arms length price at Nil. 12. The Hon'ble Delhi High Court in the case of CIT vs. EKL Appliances (Supra) has examined a similar issue whether the TPO has power to restrict it to nil when he was supposed to have determined the arms length price of the international transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by 11'ay 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 made in the context of Section 57(iii) of the Act where the language is somewhat narrower than the language employed in Section 37(1) of the Act. This fact is recognized in the judgment itself. The fact that the language employed in Section 37(1) of the Act is broader than Section 57(iii) of the Act makes the position stronger. 20. In the case of Sassoon J. David & Co. Pvt. Ltd. v. CIT, (1979) 118 ITR 261 (SC), the Supreme Court referred to the legislative history and noted that when the Income Tax Bill of 1961 was introduced, Section 37(1) required that the expenditure should have been incurred "wholly, necessarily and exclusively" for the purposes of b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is not contemplated or authorized". 13. The principles laid down by the Hon'ble Delhi High Court in the above said case equally applies to the facts of the case. Even though the learned CIT (DR) tried to distinguish on the reason that the facts are different the ratio decidendi in the above said case is about the powers of the TPO to determine the ALP at nil value. As in the above said case what the TPO has done in the present case is also to hold that assessee need not pay any royalty on the presumption that assessee is a contract manufacturer. 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. On that principle alone, we cannot approve the order of the TPO as it not only considered the facts wrongly but also exceeded the jurisdiction available to the TPO in examining the arms length price on a transaction. 14. Apart from the legal position stated above, even on merits the disallowance of entire royalty payment on sales to AE was n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hether assessee is a contract manufacturer or a full-fledged manufacturer, since royalty is paid for allowing assessee in utilizing the technical knowhow and the license for manufacturing activity, we are of the opinion that the payment of royalty is wholly and exclusively for the purpose of business. In view of this, we allow assessee's ground and direct AO to allow the royalty as claimed. 15. Assessee also raised one of the argument as ground that the TP adjustment so made will be within the safe harbor limit of +/- 5%. This argument can not be accepted as the International Transaction is the payment of royalty alone. The TPO determined ALP at NIL which works out to 100% variation. This is more than the safe harbor limit prescribed. Therefore this argument cannot be accepted. However, we have held that the payment of Royalty is wholly and necessarily for the purpose of business. 16. The rate of Royalty at 5% was allowed by CIT(A) on part of sales. Revenue has not come in appeal or objected to the said rate. Therefore, we hold that 5% royalty rate is at arm length price. For all the reasons stated above, we hold that assessee's payment of royalty cannot be disallowed inv ..... X X X X Extracts X X X X X X X X Extracts X X X X
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