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TMI Blog2024 (7) TMI 849X X X X Extracts X X X X X X X X Extracts X X X X ..... ld invariably involve sale of the said goods to its AEs as well. The transfer of technical know-how and licensing of technology was essential to enable STI to undertake its activities independently. Neither the TPO nor the DRP engaged in a recharacterization of the transaction entered into between the parties nor was there any material existing on the record to demonstrate that the transaction entered into between STI and its AEs was distinguishable from those which would have been entered into by independent enterprises behaving in a commercially rational manner. Neither the TPO nor the DRP rested their opinion on any material or evidence which may have tended to indicate that the transactions undertaken by STI would not satisfy the test of commercial expediency or prudence. Neither the production of the goods in question nor the supply thereof was shown to be motivated or based upon directives of Samsung Korea. Those transactions clearly appear to have been guided and informed by STI s business and commercial interests. The mere factum of STI being a wholly owned subsidiary of Samsung Korea does not necessarily entail that it was engaged in the manufacture and sale of mobile hand ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ones, the individual value of the mobile handsets and other distinguishing factors. In the absence of specific data pertaining to the said transactions or of any evidence suggesting that Samsung Korea was in control of the overseas sales by STI to AEs or unrelated parties, we find ourselves unable to conclude that the AEs of STI had not been charged for the cost of technological know-how obtained or that STI had not been renumerated as an independent manufacturer by its AEs . TPO as well as the DRP clearly appear to have misconstrued the agreement in terms of which know-how and expertise stood licensed to STI. Decided against revenue. - HON'BLE MR. JUSTICE YASHWANT VARMA HON'BLE MR. JUSTICE PURUSHAINDRA KUMAR KAURAV For the Appellant Through: Mr. Sanjay Kumar and Ms. Easha Kadian, Advocates For the Respondent Through: Mr. Himanshu Sinha, Mr. Bhuwan Dhoopar and Mr. Parash Bisvval, Advocates JUDGMENT YASHWANT VARMA, J. 1. The Principal Commissioner impugns the order of the Income Tax Appellate Tribunal [Tribunal] dated 23 May 2017 rendered for Assessment Year [A.Y.] 2008-09. By our order of 09 February 2018, we had admitted the appeal on the following solitary question of l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the total income of the assessee. Based on the above, a Draft Assessment Order came to be framed on 29 December 2011. The aforesaid was assailed by way of objections preferred before the Dispute Resolution Panel [DRP]. The DRP, however, in terms of an order of 27 September 2012 upheld the additions which were proposed. Basis the above, a final assessment order came to be framed on 26 October 2012. 6. It becomes pertinent to note that during the pendency of the aforesaid proceedings, identical questions arose for A.Y. 2007-08. The appeal for that year reached the Tribunal which rendered a final decision thereon on 21 June 2013. While dealing with the issue of royalty and the additions which were made in that respect pursuant to the recommendations of the TPO as affirmed by the DRP, the Tribunal held as follows: - 6.2 We have carefully heard the submissions and perused the records. We find that assessee in this case has paid the royalty to its AEs on total exports sales of Rs. 1,724,554,461/- to AE, the assessee had deducted the cost of goods sold and on the net sales of Rs. 333,522,421/- royalty @ 8% at Rs. 26,681,794/- had been paid. The TPO observed from the transfer pricing d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see to group companies are not driven by open market conditions. It is further noted that exports sales to AE were to fellow subsidiary (i.e. Samsung Singapore, Samsung UAE and Singapore, Phillipines). The royalty in this regard was paid to SEC Korea. In these circumstances, we find considerable cogency in the assessee's Submissions that owning to the fact that the assessee has made some sales to some other overseas group companies, SEC Korea cannot be deprived of its right to earn an arms length return on these sales, in return for the R D investments it has made over the years. 6.5 We further note that the contract manufacture has not been defined under the Income Tax Act. The definition of contract manufacture, as per OECD commentary at para 7.40 is stated as under:- 7.40 Contract manufacturing is another example of an activity that may involve intra-group services. In such cases the producer may get extensive instruction about what to produce, in what quantity and of what quality. The production company bears low risks and may be assured that its entire output will be purchased, assuming quality requirements are met . In such a case the production company could be considere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... I transactions other than the Royalty payments made on AE related export sales. It has been submitted that for balance export sales also royalty was being paid by the appellant @ 8% under the same royalty agreement to SEC Korea. It has been submitted that the TPO has ignored the crucial fact that in the instant case, the basis of payment of royalty is not lump sum but on a percentage of per unit basis of sale. It is same whether the sales are domestic or export sales. For even export sales made to third independent parties royalty is being collected by SEC at the same rate. 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 page 127, para 7.2 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee under the Technology Agreement, computed on the basis of the entire production/sales. This remains undisputed. Further, it is also undisputed, as noted by the ld. CIT(A), that for the purpose of computing the fees to be paid for production, no distinction was made between the products sold to the AE or to independent parties. As such, the fee was paid on the sales made to the AE also. There was no material brought by the TPO to demonstrate that the price on sales made to the AE was not at an arm's length. That being so, it was at market determined prices that the sales were made by the assessee. Moreover, it goes unchallenged that the fees paid under the Technology Agreement comprises an integral part of the cost of production, which was recovered from the sale price. It was thus, that so far as regards the sales made to the AE, the amount of fees paid under the Technology Agreement was recovered by the assessee from the AE as part of sale price. This being so, such fee paid became revenue neutral, that is to say, in case the assessee did not pay the fees on. the sales made to the AE, a corresponding reduction in the price charged to the AE would have to be given by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was a wholly owned subsidiary and there would thus be no justification for it having paid any consideration to Samsung Korea, the parent entity. 9. Mr. Kumar, learned counsel appearing for the appellant during the course of oral arguments submitted that STI was operating in the capacity of a contract manufacturer on behalf of Samsung Korea, inasmuch as STI purchased raw material to manufacture goods in India and exported the same to its AEs . Learned counsel contended that royalty, as a concept, in the context of the present appeal, envisages payments made to a third party for its intangible expertise, i.e., the technical know-how required for the manufacture of goods. It was on this basis that Mr. Kumar commended for our acceptance the findings of the TPO, which had determined the ALP of the royalty paid by STI to be Nil , since the transaction was not at arm s length and amounted to the collection of royalty payments on exports made to itself . 10. It is in the aforesaid backdrop that Mr. Kumar drew our attention to the judgement of the Court in Sony Ericsson Mobile Communication India P. Ltd. v. Commissioner of Income-tax 2015 SCC OnLine Del 8083 and to the following observatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted or stated. There is no material or justification to hold that no independent party would incur the AMP expenses beyond the bright line AMP expenses. Free market conditions would indicate and suggest that an independent third party would be willing to incur heavy and substantial AMP expenses, if he presumes this is beneficial, and he is adequately compensated. The compensation or the rate of return would depend upon whether it is a case of long-term or short-term association and market conditions, turnover and ironically international or worldwide brand value of the intangibles by the third party. 11. Learned counsel for the appellant relying upon the decision in Sony Ericsson, argued that the transaction between the parties was lacking in economic substance because royalty payments were in effect payments made by STI to itself. The arguments of Mr. Kumar proceeded on the premise that STI was a contract manufacturer which purchased raw materials from its AEs and utilized the same for the manufacturing and subsequent export of goods to its AEs, because of which payments made to Samsung Korea ought to be treated as capital expenditure. Accordingly, learned counsel urged that the t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct, the business model of the assessee is consistent with the business model followed in the case of contract manufacturers where no royalty is paid in respect of goods manufactured and sold on contract basis to the group entities. If the assessee has not been remunerated as if it was an independent manufacturer using intangibles in its own right to manufacture the goods sold to group entities. it is obvious that it was acting as a contract manufacturer and there was no reason that why it should have paid any royalty to SEC Korea in respect of sales made to the group entities. In fact. the amount of Royalty disallowed by the TPO is much less than the amount foregone by the assessee from its group entities by way of earning a lower Gross Profit. 14. It was on the aforesaid basis that Mr. Kumar, drawing strength from the observations of the DRP, contended that STI had not charged its AEs for the technical know-how utilized for the manufacture of goods but had embedded the cost of the same in the sales price of goods sold to those entities. Resultantly, Mr. Kumar argued that the entire transaction was in effect a profit shifting mechanism, particularly because royalty payments made by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o Samsung Korea and this too lent credence to the position which was taken by the respondent/ assessee. 18. Of equal significance were the findings arrived at by the Tribunal to the effect that while Samsung Korea exercised a close watch and overview with respect to the quality of raw materials utilized and the production process, it neither controlled nor determined the quantity of production or for that matter the terms on which sales were to be or had been affected. It significantly found that the dealings between the two entities were not based on any assurance that the entire production of STI would be accepted or purchased by its parent entity. The Tribunal had also found a complete absence of a directive operating upon the respondent-assessee mandating it to compulsorily sell goods to its AEs overseas. The assertion of STI that the sales made to AEs was on the basis of independent negotiations between the two sides and governed by independent contracts had gone unquestioned. It was on an overall conspectus of the aforesaid that the Tribunal had ultimately come to conclude that the assumption of the respondent-assessee being a contract manufacturer as well as the premise of p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t could have been exercised by the TPO in terms of Rules 10A to 10E of the Income Tax Rules, 1962 [Rules] . As was rightly contended by Mr. Sinha, the statutory authority conferred upon the TPO can only extend to an examination of the appropriateness of the method adopted for the purposes of determining ALP or evaluating the enlistment of comparables. However, Mr. Sinha submitted, the TPO would neither be justified nor could it be countenanced to have the jurisdiction to question commercial expediency or genuineness of need. According to learned counsel, these aspects stand duly elucidated in Commissioner of Income-tax. v. EKL Appliances Ltd. 2012 SCC OnLine Del 1897, where the Court had explained the scope of the authority of the TPO in the following terms: - 22. Even rule 10B(l)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was unremunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g Officer had pointed out that the assessee has qualified accounting staff which could have handled the audit work and in any case the assessee has paid audit fees to external firm. Similarly, the Transfer Pricing Officer was of the view that the assessee had management experts on its rolls, and, therefore, global business oversight services were not needed. It is difficult to understand, much less approve, this line of reasoning. It is only elementary that how an assessee conducts his business is entirely his prerogative and it is not for the Revenue authorities to decide what is necessary for an assessee and what is not. An assessee may have any number of qualified accountants and management experts on his rolls, and yet he may decide to engage services of outside experts for auditing and management consultancy; it is not for the revenue officers to question the assessee's wisdom in doing so. The Transfer Pricing Officer was not only going much beyond his powers in questioning commercial wisdom of the assessee's decision to take benefit of expertise of Dresser Rand US, but also beyond the powers of the Assessing Officer. We do not approve this approach of the Revenue auth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ration of the facts-state that the arm's length price is 'nil' given that an independent entity in a comparable transaction would not pay any amount. However, this is different from the Transfer Pricing Officer stating that the assessee did not benefit from these services, which amounts to disallowing expenditure. That decision is outside the authority of the Transfer Pricing Officer. This aspect was made clear by the Income-tax Appellate Tribunal in Deloitte Consulting India Pvt. Ltd. v. Deputy CIT/ITO (2012) 19 ITR (Trib) 378 (Mumbai) ; (2012) 137 ITO 21 (Mumbai) (page 402 of 19 ITR (Trib)): On the issue as to whether the Transfer Pricing Officer is empowered to determine the arm's length price at nil , we find that the Bangalore Bench of the Tribunal in Gemplus India P. Ltd. 2010-TII-55-ITAT-BANG-TP, held that the assessee has to establish before the Transfer Pricing Officer that the payments made were commensurate to the volume and quality service and that such costs are comparable. When commensurate benefit against the payment of services is not derived, then the Transfer Pricing Officer is justified in making an adjustment under the arm's length price. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ea for the following reasons. A perusal of the facts on the record reveals that STI was a wholly owned subsidiary of Samsung Korea and which was engaged in the manufacture and sale of mobile handsets under the brand name of Samsung in the Indian and overseas market and which would invariably involve sale of the said goods to its AEs as well. The transfer of technical know-how and licensing of technology was essential to enable STI to undertake its activities independently. 23. We note in this regard that neither the TPO nor the DRP engaged in a recharacterization of the transaction entered into between the parties nor was there any material existing on the record to demonstrate that the transaction entered into between STI and its AEs was distinguishable from those which would have been entered into by independent enterprises behaving in a commercially rational manner. In our considered opinion, the decision of the Court Sony Ericsson far from lending credence to the arguments addressed by the appellant would be liable to be read as negativing the challenge which stands raised. 24. As we peruse the record, we find that neither the TPO nor the DRP rested their opinion on any materia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company could be considered as performing a service, and the cost plus method could be appropriate , subject to the principles in Chapter II. 7.40. Another example of an activity that may involve intra-group services is manufacturing or assembly operations. The activities can take a variety of forms including what is commonly referred to as contract manufacturing. In some cases of contract manufacturing the producer may operate under extensive instruction from the counterparty about what to produce, in what quantity and of what quality. In some cases, raw materials or components may be made available to the producer by the counterparty. The production company may be assured that its entire output will be purchased, assuming quality requirements are met. In such a case the production company could be considered as performing a low-risk service to the counterparty, and the cost plus method could be the most appropriate transfer pricing method, subject to the principles in Chapter II. 28. Viewed in light of the facts of the present appeal, it becomes apparent that STI does not fall under the ambit of a contract manufacturer either in terms of the OECD Guidelines, 1995 or for that matt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accurately determining a market price in the absence of market forces or when adopting a particular commercial strategy. It is important to bear in mind that the need to make adjustments to approximate arm s length conditions arises irrespective of any contractual obligation undertaken by the parties to pay a particular price or of any intention of the parties to minimise tax. Thus, a tax adjustment under the arm s length principle would not affect the underlying contractual obligations for non-tax purposes between the associated enterprises and may be appropriate even where there is no intent to minimise or avoid tax. The consideration of transfer pricing should not be confused with the consideration of problems of tax fraud or tax avoidance, even though transfer pricing policies may be used for such purposes. 31. At this juncture, we additionally observe that Samsung Korea, as the owner of the technological know-how which was inherently required for STI to manufacture the mobile handsets under the brand name of Samsung, was entitled to receive an arms length return on the value of the intangibles provided by it to STI in the form of royalty payments. As discussed hereinabove, ST ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 34. We additionally take note of the findings of the Tribunal in its order dated 21 June 2013 regarding the scope of oversight maintained by Samsung Korea over STI and which had found that although Samsung Korea was involved in overseeing the quality of raw materials and the production process of goods, it was not associated with controlling the quantity of production or the terms and conditions underlying the sale of goods. This is in addition to the absence of evidence adduced on the record to demonstrate that STI was bound by directives issued by Samsung Korea compelling STI to mandatorily sell goods to its AEs overseas. Furthermore, the assertion that independent negotiations and independent contracts underlie the sales by STI to its AEs remained uncontroverted. This leads us to the inevitable conclusion that the view taken by the AO and DRP, that STI was a contract manufacturer and had made royalty payments to itself was thoroughly misconceived. Accordingly, and for all of the aforesaid reasons, we are of the view that the premise of the payment of royalty being to self in the case of and where such a payment be made to a holding company is wholly untenable. 35. It becomes pe ..... X X X X Extracts X X X X X X X X Extracts X X X X
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