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TMI Blog2025 (4) TMI 387X X X X Extracts X X X X X X X X Extracts X X X X ..... sed supra Addition on a/c of TPO adjustment after giving effect to DRP's directions 6,39,04,550/- Addition on a/c of interest income 4,18,312/- Total addition 6,43,22,862/- Gross total income 3,59,80,706/- Brought forwarded losses of earlier years set off 3,51,36,946/- Total income assessed 8,43,760/- Details of brought forwarded losses including absorbed depreciation: A.Y. Losses for the year claimed by the assessee (Rs.) Amount of loss which is allowed to be c/f after scrutiny assessment (Rs.) Amount of loss adjusted with effect of this order Amount of loss which is allowed to be c/f after scrutiny assessment A B C 2010-11 8,58,56,154/- 4,04,82,096/ -* 3,51,36,946/- 53,45,150/- 2015-16 5,54,03,450/- 5,54,03,450/- Nil 5,54,03,450/- *This C/F loss is determined while passing order for A.Y. 2010-11 on 21.01.2019" First the Facts 5. The assessee company is engaged in business of manufacturing of Automobile components - carburetors of motorcycles & two wheelers; throttle body for four wheelers and plastic intake manifold for four wheelers. 6. The assessee company was establis ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for use of know-how 2,25,65,500/- 5. Mikuni Corporation, Japan Payment of supervision fee 97,28,046/- 6. Mikuni Corporation, Japan Payment of royalty 6,08,80,707/- 7. Mikuni Corporation, Japan Reimbursement of expenses 4,70,51,927/- 8. Mikuni Corporation, Japan Interest on external commercial borrowings 29,64,911/- 9. Mikuni Corporation, Japan Fee for provision of guarantee 7,65,422/- 10. Mikuni Indonesia Recovery of expenses 24,97,312/- On receipt of reference, the Transfer Pricing Officer passed order dated 31.10.2019 u/s. 92CA (3) of the 1.T.Act, 1961 after analyzing the facts of the case in detail. The Transfer Pricing officer is stated to have discussed every issue in detail after giving adequate opportunities of being heard to the assessee company. Order was passed by the Dy. Commissioner of Income Tax, Transfer Pricing Officer-2(3) (2), New Delhi. International Transaction of purchase of raw material, components and spare parts :- 11. After notice u/s. 92CA of the Act was issued to the assessee, in the transfer pricing proceedings the assessee company was represented, by its authorized representative. Show-cause notice dated 09.10.2019 was issued ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (A) 229,58,89,647/- OP/Sales of comparables (B) 7.21% Arm's Length Margin C=A*B% 16,55,33,644/- Arm's Length Cost D=(A-C) 213,03,56,003/- Cost shown by the assessee(E) 225,06,98,359/- Difference F=(E-D) 12,03,42,356/- International transaction related to Purchase of Goods 74,21,23,717/- % of Cost of International transaction 32.97% Proportionate adjustment of difference 3,96,80,536/- Accordingly, TPO proposed an adjustment of Rs. 3, 96, 80,536/ -. International transactions-Payment of Royalty :- As regards said international transactions i.e. payment of royalty, TPO issued show-cause notice dated 09.10.2019. The assessee company furnished its reply. After considering the reply and the material available on record, TPO made following adjustment :- "5.6 Calculation of Arm's length price: In view of the above discussion, following four comparable agreements are comparable to the assessee. S. No. Licensor Licensee Royalty rate 1 Environmental Recycling Technologies Plc LBO Capital Inc 3.00% 2 Axion Power International, Inc. LCB International, Inc. 2.00% 3 Newgen Technologies Inc. Newgen Fuel Technologies Ltd. 0.12% 4 Litelfuse, Inc. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e impugned assessment order, which is under challenge by way of present appeal. 13. hence, this appeal against the impugned order passed by the Assessing Officer. 14. Arguments heard. File perused. 15. As noticed above additions have been made vide impugned assessment order, as regards the following two types of international transactions; (i) Purchase of material from Associated Enterprise (in short 'AE') (ii) Payment of royalty to Associated Enterprise. Only the said two additions/adjustments are the subject matter of this appeal. Learned AR for the appellant and ld. DR for the department have restricted their arguments only as regards the said additions/adjustments. 16. As noticed above, the assessee selected Cost Plus Method (in short 'CPM') as the most appropriate method for transfer pricing, but Id. TPO rejected said method selected by the assessee, and concluded that Transactional Net Margin Method (in short 'TNMM'), as the most appropriate method. 17. Ld. AR for the appellant has submitted that ld. TPO rejected CPM as most appropriate method only on the ground of non availability of reliable data in the data of the comparable companies, and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ioner of Income Tax, Alwar: S. No. Name of AEs Description of International Transaction Amount (Rs.) 1. Mikuni Corporation Purchase of Raw material, components and share parts 74,21,23,717 2. Mikuni Corporation Exports Sales 22,50,77,289 3. Mikuni Corporation Purchase of fixed assets 5,12,79,433 4. Mikuni Corporation License fee for use of know-how 2,25,65,500 5. Mikuni Corporation, Japan Payment of supervision fee 97,28,046 6. Mikuni Corporation, Japan Payment of royalty 6,08,80,707 7. Mikuni Corporation, Japan Reimbursement of expenses 4,70,51,927 8. Mikuni Corporation, Japan Interest on external commercial borrowings 29,64,911 9. Mikuni Corporation, Japan Fee for provision of guarantee 7,65,422 10. Mikuni Indonesia Recovery of expenses 24,97,312 On receipt of reference, the Transfer Pricing Officer passed order dated 31.10.2019 u/s 92CA(3) of the 1.T.Act, 1961 after analyzing the facts of the case in detail. The Transfer Pricing officer is stated to have discussed every issue in detail after giving adequate opportunities of being heard to the assessee company. Ultimately, order was passed by the Dy. Commissioner of Income Tax, Transf ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... being the most appropriate method, in the following manner, namely: (a)............................ (b)............................ (c) Cost plus method, by which, (i) The direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined, (iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market, (iv) The costs referred to in sub-clause (1) are increased by the adjusted profit mark-up arrived at under sub-clause (iii), (v) the sum so arriv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the analysis may be adversely affected, for the reasons set forth in paragraphs 3.29-3.32. Thus, the safeguards described in paragraphs 3.34-3.40 may be relevant in assessing the reliability of such analyses." "2.40 While precise accounting standards and terms may vary, in general the costs and expenses of an enterprise are understood to be divisible into three broad categories. First, there are the direct costs of producing a product or service, such as the cost of raw materials. Second, there are indirect costs of production, which although closely related to the production process may be common to several products or services (e.g. the costs of a repair department that services equipment used to produce different products). Finally, there are the operating expenses of the enterprise as a whole, such as supervisory. general, and administrative expenses. 2.41 The distinction between gross and net margin analyses may be understood in the following terms. In general, the cost plus method will use margins computed after direct and indirect costs of production, while a net margin method will use margins computed after operating expenses of the enterprise as well, it must be reco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompanies, Cost Plus Method would not be a reliable method as the results are based on approximations and assumptions. Instead, considering PBIT would be a more reliable measure in the service industry. 5. It is clearly stated that the data used by the company in its own case and in the case of comparable companies while computing the cost is unreliable and thus leading to incorrect comparability. 6. There is no dispute on the point that TNMM and CPM are different methods but when the taxpayer is compensated on all its cost, the most appropriate method is TNMM in the absence of reliable data in the case of comparable companies in regard to the direct and indirect costs of production in connection with rendering of software development services. 7. There is no uniformity in treating certain expenditure as direct and indirect among the companies in India due to the absence of any statutory or regulatory requirements of such disclosures in the case of service providers in India. In the absence of such uniformity in disclosure, it is difficult to arrive at the direct and indirect costs of production in connection with rendering software services and thus CPM cannot be applied. 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e under the principles of Chapter 1). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particular that the net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter 1) should ideally be established by reference to the net margin that the same taxpayer earned in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. A functional analysis of the associated enterprise and, in the latter case, the independent enterprise is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results. Further, the other requirements for comparability, and in particular those of paragraphs 3.34-3.40, must be applied. b) Strengths and weaknesses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mely CUP, RPM, CPM, PSM, & TNMM are mentioned in Sec. 92C read with rule 10C. The most appropriate method has to be applied for computation of the arm's length price. It will depend on facts and circumstances of each particular international transaction ... " The Supreme Court has also held TNMM to be the most appropriate method in the case of Service PE "in our view apart from the orders passed by the TPO/AO the said method (TNMM) is the appropriate method in the case of service PE as the TNMM apportions the total operating profit arising from the transactions on the basis of sales, costs, assets etc ... " Further as per OECD (see TPG paragraphs 2.39-2.55) CPM method probably is most useful where: 1. goods are sold by a manufacturer that does not contribute valuable unique intangible assets or assume unusual risks in the controlled transaction, such as may be the case under a contract or toll manufacturing arrangement, or 1. ii) the controlled transaction is the provision of services for which the provider does not contribute any valuable unique intangible assets or assume unusual risks. In the case of the assessee, he fails to qualify the above discussed situation a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere also operating in same economic environment and all were playing same game of price cutting and volume generation, and that any adjustment by way of capacity adjustment and risk adjustment would change the level playing field. Therein, Ld. CIT (A) granted capacity underutilization adjustment in depreciation allowance, by making adjustments in depreciation figures of the tested party as also of the comparables. Ld. CIT (A) had taken note of assessee's submission that the production of the assessee in the relevant years was much below the installed capacity. Co- ordinate Bench approved the conclusions arrived at by Ld.CIT (A). In IKA India Pvt. Ltd. v. Dy., CIT, IT(TP) No.2192/Bang/2017, decided on 17.9.2018 by ITAT, Bangalore, the product manufactured by the assessee was laboratory and processing equipment and the comparable company was in manufacture of pacemaker for implanting in heart. Same could be categorized as "manufacture of equipment". Accordingly, it was observed by the Co-ordinate Bench that the comparable company was rightly not excluded for the purpose of comparison on the ground of product different. In IKA's case (supra), the assessee had pleaded before ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any such software services, and as such, it can safely be said that ld. TPO rejected CPM while taking into consideration by way of misconception that the assessee company has been dealing in software services as well. Therefore, learned AR has urged that the order passed by Learned TPO deserves to be set aside. In response, ld. DR for department has not raised any contention to explain the aspect of referring to software services, when the assessee company is not involved in any software services. 21. No doubt, Ld. TPO in points 2, 7 & 8 at page 16 of the order, made certain observations about the rendering of software services, their market price, direct and indirect costs of production in connection with running of software services and the price charged in case of software industries, but it appears that said paragraphs have inadvertently crept in while referring to the OECD guidelines and discussing non-relevancy of CPM method selected by the assessee. In view of the detailed discussion by Learned TPO, while dealing with the contentions raised on behalf of the assessee on each point, no adverse inference can be drawn when the above observations as regards software industry ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be discarded from consideration, or that CPM method selected by the assessee be applied in determination of ALP. A perusal of the final assessment order would reveal that the Assessing Officer considered all the grounds raised by the assessee after the passing of the order by Learned DRP, discussed the same and gave effect to the directions issued by Learned DRP on each point. 24. In view of the discussion, the assessment as regards payments made for purchase of raw material, by way of international transactions, deserves to be upheld. International transactions- pertaining, payment of royalty. 25. As noticed above, on this aspect, separate addition of Rs. 3, 46, 97,608/- has been made. It may be mentioned here that after conducting proceeding u/s. 92CA of the Act, ld. TPO made adjustment of Rs. 3,77,46,038/-. Show-cause notice dated 09.10.2019 issued by ld. TPO to the assessee was to the following effect: "The assessee benchmarked the transaction relating to Payment of Royalty using Cost plus Method and thus shows that the transaction is at Arm length. The Gross profit to Gross Cost (GP/GC=Gross Cost Plus) ratio is taken as the profit level indicator (PLI) in the CPM anal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ules, Ld. TPO observed that payment of royalty is a class of transaction of its own and requires separate analysis, and further that said transaction was being analyzed separately under CUP method. Ld. TPO was of the view that benchmarking said transaction under CPM, after aggregating the same with other transaction, was not acceptable, the reason being that such transaction is a separate class of transaction to be bench- marked separately and cannot be aggregated with other transactions particularly when royalty payment transactions and other transactions are not closely linked, and royalty payment transaction are not a significant part of the total cost of the assessee. Ld. TPO observed that the assessee had failed to prove the intrinsic relationship between royalty and other transactions. At the same time, ld. TPO was of the view that under TNMM, it is the net margin realized from international transaction which is to be analysed and not the enterprise level earnings. In this regard, ld. TPO referred to sub-clause (i) of clause (e) of Rule 10B (i) of IT Rules, 1962, which read as under :- "(i) the net profit margin realized by the enterprise from an international transactio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee to the AE for said services, is an arm length price. TPO is also to find out whether the prices paid by the assessee for availing of the services are at arm's length price or not. Provisions as contained in Chapter X of the Act, relating to Transfer Pricing provide for determination of arm's length price or cost of an international transaction between two associated enterprises. In Sony Ericsson's case, Hon'ble Delhi High Court has observed that TNM method is equally effective and reliable when applied to closely linked and continuous transactions. In L.G. Electronics India (P) Ltd.'s case (supra), the assessee had benchmarked the international transaction of royalty by clubbing it along with the other international transactions, such as, import of raw material and components, service spares, export of finished goods along with commission, training fee, import of software services etc. All these were benchmarked in a combined manner under TNM method on an entity level. It was held that royalty is not closely linked with other international transactions and hence should be benchmarked separately. Further, it was held that evidently transaction of roya ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the contention raised on behalf of the Revenue that the royalty payment has to be benchmarked separately. Proceeding further, indisputably, in its transfer pricing study, the assessee did not conduct any separate analysis of the royalty payments made by it to its AE. Thereupon, the department proceeded to conduct fresh search to find out suitable comparable agreement, so as to identify royalty rates. As noticed above, Ld. TPO found only following three agreements to be comparable to the agreement entered into by the assessee: S. No. Ref. Licensor Licensee Royalty Rate 1 L30729 Axion Power International, Inc. LCB International, Inc. 2% 2 L8517 Newgen Technologies Inc. Newgen Fuel Technologies Ltd. 0.12% 3 L4054 Littelfuse, Inc. Pacific Engineering Co., Ltd. 2.50% Average 1.54% As noticed above, the assessee paid royalty at the rate of 5 percent of the Net sales of the products or parts, whereas, Learned TPO found that as per the above data from the comparables, average royalty rate was only 1.53%, much lower than royalty rate paid by the assessee. It was for the assessee to contest the show cause notice issued by the Revenue proposing benchmarking at the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd it is observed that product defined in agreement is similar to assessee. Accordingly, it be considered as comparable agreement. 30. The assessee selected 8 comparable agreements to benchmark the transactions pertaining to the payment of royalty using CUP method. After examining the material made available, ld. TPO observed, as regards the newly proposed comparable agreements as under: S.No Name of Licensor Name of Licensee Assessee's comment TPO's Comments 1. KOREA DELPHI AUTOMOTIVE SYSTEMS COPERATION JINGZHOU HENGLONG AUTOMOTIVE PARTS CO., LTD Agreement similar This agreement has been examined by this office and it is observed that product defined in agreement is not similar to assessee as the Licensor is owner of manual gear assembly fc GMDAT's Matiz (Project Name. M150 & M200). Therefore, this agreement is not comparable. Accordingly, it be not considered as comparable agreement. 1. RESEARCH FRONTIERS INCORPORATED BOS Gmbh & Co. KG * Agreement similar This agreement has been examined by this office and it is observed that product defined in agreement is not similar to assessee as the Licensor is owner of Light Valve intended for use and used as a s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agreement is similar to assessee as the Licensor is owner of any product in the automotive field which can be manufactured. Accordingly, it can be considered as comparable agreement. 1. Perpetual Industries Inc., Motor Sport Country Club Holdings, Inc * Agreement similar This agreement has beer examined by this office and it is observed that product defined in agreement is not similar to assessee as the Licensor is owner of rights in and to technology for the manufacture and use of automatic balancing systems suitable in the balancing and stabilization of rotating systems. Accordingly, it cannot be considered as comparable agreement. 31. Ultimately, TPO was of the view that following 4 agreements were comparable to the assessee. S. No. Licensor Licensee Royalty Rate 1 Environmental Recycling Technologies plc LBO Capital Inc 3.00% 2 Axion Power International, Inc. LCB International, Inc. 2.00% 3 Newgen Technologies Inc. Newgen Fuel Technologies Ltd. 0.12% 4 Littelfuse, Inc. Pacific Engineering Co., Ltd. 2.50% Average 1.905% 32. Taking into consideration, the average rate of 1.905%, ld. TPO, while using CUP method, computed Arm's length price in said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... riation in the terms of agreement would not change thefundamental nature of a royalty agreement. The objection on this count is, accordingly, rejected. 3.9.1.2 Licensor-LitteIfuse Inc. Licensee: - Pacific Engineering Co., Ltd. It is a technology license agreement for blade fuse configuration. The assessee contends that its terms and conditions are completely different from that of the assessee's Agreement. Also, this agreement was not in force during the relevant year i.e. agreement had expired and the assessee has entered into an agreement for India territory whereas the above agreement covers multiple countries in Europe and Asia including Japan, Iran, Germany, North Korea, Spain etc." 37. While dealing with ground No. 12 relating to rejection of comparable royalty agreements identified by the assessee for benchmarking its transactions, ld. DRP observed in the following manner and rejected the objections raised by the assessee: "3.10 Ground no 12 relates to the rejection of the comparable royalty agreements identified by the assessee for benchmarking its transaction. The assessee merely contested the rejection the following two sets of comparables in its synopsis: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee was unable to substantiate the need for payment of technical assistance fees to its foreign AE. TPO had also observed that neither any cost benefit analysis nor any benchmarking exercise was undertaken at the time of entering into the agreement. Therein, as regards payment of royalty, TPO had accepted TNMM in respect of payment of royalty as well, but disputed its application for payment of technical assistance and rather CUP method was sought to be applied. Hon'ble High Court held that TNMM had to be applied in respect of the technical fee payment too, TPO having accepted TNMM for other international transactions. Additional Evidence-Whether deserves to be produced here? 38. It may be mentioned here that during pendency of the appeal, on behalf of the appellant, an application for additional evidence came to be filed to bring on record three Royalty agreements as described in the Index prepared on 28.8.2024, for their inclusion in the set of comparables for testing Royalty, in the event it was held that it required separate benchmarking. Rule 46A of IT Rules, 1962 clearly provides that the appellant shall not be entitled to produce any additional evidence except ..... X X X X Extracts X X X X X X X X Extracts X X X X
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