Income Tax Appellate Tribunal - Delhi
Mitsubishi Electric Automotive India ... vs Dcit, Gurgaon on 29 October, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
'I-1' BENCH, NEW DELHI
BEFORE SHRI N.K. BILLAIYA, ACCOUNTANT MEMBER,
AND
SMT BEENA A. PILLAI, JUDICIAL MEMBER
ITA No. 312/DEL/2015
[A.Y 2010-11]
Mitsubishi Electric Automotive [I] Pvt Ltd Vs. The Dy. C.I.T
Plot No. 167-170, Sector 5 Circle - 2
IMT, Manesar, Gurgaon Gurgaon
PAN : AABCM 8474 A
[Appellant] [Respondent]
Date of Hearing: 11.10.2018
Date of Pronouncement : 29.10.2018
Assessee by : Shri Ajay Vohra, Sr. Adv
Shri Neeraj Jain, Adv
Shri Ramit Katyal, CA
Revenue by : Shri Sanjay I. Bara, CIT-DR
ORDER
PER BEENA A PILLAI, JUDICIAL MEMBER
Present appeal has been filed by assessee against final assessment order dated 28.02.2014 framed u/s 143(3) r.w.s 144C(13) of Income-tax Act, 1961 [hereinafter referred to as 'the Act]' for A.Y 2010-11 against following grounds of appeal:
"1. That the assessing officer erred on facts and in law in completing the assessment under section 144C read with section 143(3) of the Income-tax Act, 1961 ('the Act') at an income of Rs. 52,40,79,350 as against the income of Rs. 36,00,05,207 returned by the appellant.
ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
That the assessing officer erred on facts and in law in making an adjustment of Rs. 13,31,08,735 allegedly on account of the difference in the arm's length price of the international transaction of import of finished goods on the basis of the order passed under section 92CA(3) of the Act by the TPO. 2.1 That the DRP/TPO erred on facts and in law in rejecting Transactional Net Margin Method ("TNMM") applied by the appellant in the Transfer Pricing Documentation and substituting the same with Resale Price / Method ("RPM") for benchmarking of the international transaction of j import of finished goods.
2.2 That the DRP/TPO erred on facts and in law in not appreciating the fact that TNMM was accepted by the revenue authorities in the preceding assessment years for the purpose of benchmarking the international transaction of import of finished goods.
2.3 That the DRP/TPO erred in not appreciating the functional profile of the assessee and applying the RPM for the purpose of benchmarking the international transaction of import of finished goods undertaken by the appellant, a limited risk distributor. 2.4 That the DRP/TPO erred on facts and in law in not appreciating that having regard to the fact and circumstances of the case and due to lack of data of the comparable companies for computation of gross profit margin, RPM could not be applied as the most appropriate method for the purpose of benchmarking the international transaction of import of finished goods. 2.5 That the DRP/TPO erred on facts and in law in ignoring the fact that reliable gross profit margin cannot be computed in case of the comparable companies due to differences in classification of 2 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
expenses as direct and indirect expenses in the audited accounts. 2.6 That the DRP/TPO erred on facts and in law in rejecting two comparable companies, namely, Sri Aruna Auto..Service Ltd. and PAE Ltd. considered by the appellant in the Transfer Pricing Documentation without granting opportunity of being heard and thereby, violating the requirement of the proviso to section 92C(3) of the Act.
2.7 That the DRP/TPO erred on facts and in law in rejecting Sri Aruna Auto Service Ltd. and PAE Ltd., allegedly on the basis of functional dissimilarity without appreciating that these companies are functionally comparable and were accepted by the TPO in the immediately preceding assessment year.
2.8 That the DRP/TPO erred on facts and in law in not appreciating the fact that after including Sri Aruna Auto Service Ltd. and PAE Ltd. in the final set of comparable companies considered by the TPO, the international transaction would fall within the arm's length range of +/-5% as per second proviso to section 92C(2) of the Act.
2.9 Without prejudice, that the DRP erred on facts and in law in not considering the fresh search of comparables submitted by the appellant as an additional evidence for applying RPM. 2.10 Without prejudice, that the DRP/TPO erred on facts and in law in considering gross sales of the assessee instead of net sales for the purpose of applying the RPM.
2.11 That the DRP/TPO erred on facts and in law in rejecting comparability adjustment on account of working capital employed by the appellant vis-a-vis comparable companies.
3ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
2.12 That the DRP/TPO erred on the facts and in law in not being consistent while denying on the claim of working capital adjustment by the appellant, when working capital adjustments have been allowed in case of other assessees.
3. That the DRP/TPO erred on facts and in law in making an adjustment of Rs. 52,22,479 allegedly on account of the difference in the arm's length price of the international transaction of receipt of localization support.
3.1 That the DRP/TPO erred on facts and in law in determining the arm's length price of the international transaction of receipt of localization support services at nil applying CUP method allegedly concluding that no service/ benefit has been received by the appellant and therefore there is no rationale for paying the localization charges to the associated enterprise. 3.2 That the DRP/TPO erred on facts and in law in not appreciating that the transaction of payment for localization support charges is a cost to cost reimbursement and was validly benchmarked along with other closely linked transactions applying TNMM as the most appropriate method in the assembly segment, wherein, no adverse inference has been drawn by the TPO.
3.3. That the DRP/TPO erred on facts and in law in allegedly holding payment of localization support charges as duplication of expenditure incurred by the appellant and ignoring the fact that royalty payment, technical fee and localization charges are paid entirely for different purposes and are clearly distinguishable. 3.4 That the DRP/TPO erred on facts and in law in not appreciating that the expenditure incurred on account of receipt of 4 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
localization support was wholly and exclusively for the purpose of business of the appellant.
3.5 That the DRP/TPO erred on facts and in law in computing adjustment on account of difference in the arms length price of international transaction of receipt of localization of support without reasonably applying any of the prescribed methods, thereby, violating the requirements of the Transfer Pricing regulations.
4. That the DRP/assessing officer erred on facts and in law in treating expenditure incurred on account of payment of royalty of Rs. 2,57,43,018 as capital expenditure.
4.1. That the assessing officer/DRP erred on facts and in law in holding that in terms of the license agreement, the appellant secured an advantage of enduring nature.
4.2 That the assessing officer/DRP erred on facts and in law in holding that since MELCO was a closely held associated enterprise of the appellant, it cannot be ruled out that technical aid for setting-up the factory was provided to the appellant by MELCO 4.3 Without prejudice, that the assessing officer/DRP erred on facts and in law in not allowing depreciation to the appellant @ 25% on payment of royalty.
The appellant craves leave to add, alter, amend or vary from the aforesaid grounds of appeal before or at the time of hearing."
2. Brief Facts of the case are as under:
Assessee is a closely held company, and is engaged primarily into assembly of automated electrical components, which are sold to original equipment manufacturers/auto mobile manufacturers in India. Assessee is also engaged in distribution of automotive components. It is observed that assessee is 100% subsidiary of Mitsubishi Electric Corporation, Japan (AE). During the year under consideration the distribution segment contributed 42% of revenue and assembly segment contributed to 58% of total 5 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
revenue of assessee. As assessee had entered into international transaction with its Associated Enterprises (AE) , a reference was made to the Transfer Pricing Officer (TPO) to determine Arm's Length Price (ALP) in respect of international transactions undertaken by assessee. LD.TPO accordingly issued notice to assessee after going through Transfer Pricing documentation filed by assessee in respect of the international transactions entered into by assessee with its AE. Dispute arose with revenue regarding trading segment, receipt of localisation support services, technical services paid and royalty payments made to AE.
3. Ld.TPO observed that assessee entered into international transaction of import of automotive components for trading, amounting to Rs.1,57,29,67,076/- with its Associated Enterprise [AEs]. Assessee used TNMM as most appropriate method for determining arm's length price of transaction in trading segment. The PLI selected by assessee was operating profit/operating revenue and considered itself to be the tested party. For purposes of comparability assessee considered following comparables in its TP study:
4. For the purpose of application of TNMM, the assessee considered the following six comparable companies with an average operating profit margin of 4.91%:
Sl. Company Name Weighted
No. Average
1. George Oakes Ltd 4.04
2. India Motor Parts & Accessories Ltd 7.95
3. Jullundur Motor Agency [Delhi] Ltd 4.56
4. Speed-A-Way Pvt Ltd 5.90
5. Sri Aruna Auto Service Ltd 1.83
6. PAE Ltd 5.16
Arithmetic Mean 4.91
6
ITA 312/Del/15 AY : 2010-11
Mitsubishi Electric Automotive India P Ltd.
5. Since operating profit margin earned by assessee from trading segment was 3.71%, therefore, it was submitted to be within arm's length range +/-5% of mean operating profit margin of the comparable companies which was at 4.91%. Assessee thus treated international transaction in trading segment to be at arm's length.
6. During proceedings before Ld.TPO, it was observed that under trading segment purchases made by assessee were directly supplied to Maruti and there is no value addition to product, in terms of brand building or expenditure of advertisement, marketing or promotion. Ld.TPO was of the opinion that trading segment should be bench marked as per Resale Price Method [RPM], which is the Most Appropriate Method [MAM], since there is direct purchase and sale without any addition to the value of goods. Assessee was thus asked to show cause, as to why, RPM should not be taken as MAM than TNMM.
7. After doing FAR analysis, Ld.TPO was of the opinion that, assessee does not undertake any economically significant functions or undertakes any value addition while supplying the products purchased from its AEs to Maruti. Ld.TPO further observed that products imported by assessee are against firm orders. Therefore, assessee does not bear any inventory risk. There is no liability to promote the product, no inventory to maintain and only when the assessee gets confirmed order from customers it procures the same from its AEs and delivers to OEMs. There is no market risk and assessee is a minimal risk distributor and hence RPM is the MAM.
7ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
8. Using RPM as MAM, Ld.TPO proceeded by rejecting two of six comparables taken by assessee and computed margin by using gross basis analysis by using following comparables:
Sl. Company Name Weighted
No. Average
1. George Oakes Ltd 9.61
2. India Motor Parts & Accessories 14.43
Ltd
3. Jullundur Motor Agency [Delhi] 11.98
Ltd
4. Speed-A-Way Pvt Ltd 13.48
Average 12.37
He accordingly computed arm's length price by using RPM as
most appropriate method comparing it with the comparables selected by assessee. The adjustments so computed in the transaction undertaken by assessee with its AE for trading segment by Ld. TPO amounted to Rs.1,31,08,735/-
9. Aggrieved by adjustment, assessee raised objections before the DRP but without any success.
10. During transfer pricing assessment proceedings, Ld.TPO noticed that assessee debited localisation expenses of Rs.52,22,479/-. Such expenses were claimed as reimbursement by assessee on cost to cost basis to its AE. Ld.TPO was of the opinion that assessee has already entered into royalty agreement with AE and was paying royalty, therefore, there was no need to pay such localisation expenses. Ld.TPO was of opinion that no independent party in similar situation would have paid and, therefore, such payments tantamount to duplication of 8 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
expenditure in independent circumstances of uncontrolled nature and, therefore, this kind of transaction will have no value and CUP for this transaction will be 'NIL'. Accordingly, assessee was asked to show cause as to why ALP of the localisation support services be not determined at 'NIL'.
11. Vide reply dated 13.12.2013, the assessee strongly contended that these are different activities and are not relatable to royalty. It was submitted that assessee is responsible for localisation of imported components/products having regard to the Indian customers' requirements. It was further submitted that assessee had to adhere to the strict quality measures and criticality of products in localisation activity undertaken, which is very limited, which was not possible without support of AE.
12. The contention of assessee did not find favour with Ld.TPO, who treated ALP by using CUP as NIL and made upward adjustment of Rs. 52,22,479/-.
13. Before DRP objection raised by assessee was not considered and Ld.TPO's findings were upheld.
14. The third addition/disallowance considered by Ld. TPO was regarding royalty payments. During assessment proceedings Ld.TPO observed that assessee paid royalty of Rs.2,57,43,018/- to AE in terms of Article VII of Technology Transfer and Patent License Agreement dated 20.07.2000. The said payment was claimed as revenue deduction in the return of income. The said claim of revenue expenditure was denied by Ld.AO, who was of the opinion that as per agreement, assessee obtained benefit of enduring nature and has exclusive right of manufacturing and selling products in India. He thus treated the expenditure as 9 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
capital in nature.
15. The ld. DRP confirmed the action of the Assessing Officer. Based upon order passed by DRP Ld. AO passed the impugned order making additions as suggested by Ld. TPO as well as approved by DRP against which it is in appeal before us now. Ld.AO on the basis of directions issued by DRP, passed final assessment order making additions as above. Aggrieved by the final assessment order, assessee is in appeal before us now.
16. Ground No. 1 is general in nature and does not require separate adjudication.
17. Ld.Counsel before starting his submissions had also submitted upon instruction regarding Ground No.2.6 as 'not pressed'. Accordingly this ground is dismissed.
18. Ground Nos. 2 to 2.12 relate to Transfer Pricing adjustment of Rs. 13,31,08,735/- on account of difference in arm's length price of international transaction of import of finished goods.
19. Ld.Counsel contended that Ld.TPO erred in taking RPM as MAM. It has been submitted by Ld. Counsel that assessee operates as a limited risk distributor and does not bear any significant market, quality or inventory risk. Ld.Counsel contended that assessee is incurring no inventory risk and absolutely 'nil' market risk. Ld.Counsel further contended that inventory turnover ratio of the comparable companies selected by assessee and accepted by Ld.TPO is 11.43%, whereas that of assessee is 16.89%. It was further submitted that unlike normal risk taking distributor who is compensated on gross margin basis, assessee is not engaged in performing significant selling 10 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
and distribution function, addition/identification of new customers, inventory management etc. Therefore, assessee is not entitled to profits arising from favourable prices movement, new customer additions or better inventory management etc.
20. Ld.Counsel stated that recharacterisation is inconsistent with the functional profile of assessee because, being a limited risk distributor, assessee is compensated on gross margin basis. It may incur losses at net level due to factors such as market conditions, efficiency/inefficiency of operations and inventory management etc. Therefore, such a compensation model would not be consistent with its functional characterisation of a limited risk distributor.
21. Ld.Counsel further pointed out that Ld.TPO has ignored the fact that significant functional and risk differences between assessee and full-fledged distribution companies considered for purpose of comparability and such differences cannot be eliminated by RPM. Therefore, TNMM should be taken as MAM.
22. Per contra, the Ld.CIT DR strongly supported findings of Ld.TPO. He drew our attention on relevant observations by Ld.TPO in respect of typical functions as a distributor performed by assessee under trading segment and characterisation of assessee in TP study to be a limited little risk distributor. He thus submitted that Ld. TPO was correct in taking RPM as MAM.
23. We have perused the records on the basis of arguments advanced by both sides.
24. The issue that emerges in ground No. 2 to 2.12 is in respect of selection of appropriate method, for determining ALP of 11 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
international transaction relating to import of products by assessee and sale to its customers.
25. In TP study filed by assessee in paper book at page 565, assessee is stated to be involved in activity of import of automotive components, for distribution in India. While performing this function, assessee has stated to undertake routine functions of custom clearance and similar port formalities. Trading activity is carried out by assessee under an arrangement with its AE, for which remuneration is received from AE.
26. Assets employed for carrying out this function are only those, necessary to perform administration and selling functions effectively.
27. Risks assumed by assessee for purpose of trading activity are generally, contract risk & foreign exchange fluctuation risk. Assessee do not have any significant risk associated with trading activity, except, foreign exchange fluctuation risk, for the payment made in foreign exchange currency by AE, whereas its revenues are in Indian currency.
28. On totality of functions, assets and risks performed by assessee under trading segment, assessee has considered itself to be having very low intensity of functions with limited risk. Assessee thus in TP Study Report characterised itself to be a limited risk bearing distributor in relation to products of related enterprise.
29. In Transfer Pricing documentation, assessee determined arm's length price of transaction of import of finished goods by applying Transactional Net Margin Method (TNMM). For purpose 12 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
of bench marking, assessee considered it to be the tested party and Operating Profit/Operating Revenue (OP/OR%) as the Profit Level Indicator (PLI).
30. On analysing limited function performed by assessee, the assets involved and risks assumed in performing the activity of purchase and Import of product from A.E. to resell, there is no dispute that assessee is incurring no inventory risk and very little market risk. Assessee places orders on its AE for purchase of goods against confirmed orders received from unrelated domestic customers and assessee does not perform any critical function such as advertisement, marketing, management of inventory etc. There is also no quarrel that customers of assessee could have purchased directly from the AE, Japan. However, Indian customers wanted to procure these goods locally from assessee rather than buying the same from their group companies. Since information relating to prices of such products is already available with Indian customer, it is difficult for assessee to charge significantly different prices.
31. In our considered opinion, a normal risk taking distributor undertakes necessary decisions and performs functions related to market strategy, pricing operation and inventory management and at the same time, bears risk only relating to fluctuations in market. A normal risk taking distributor may earn high profits and incur losses whereas, limited risk distributor, like assessee, has limited function and risk profile because key decisions relating to marketing strategy, pricing, inventory management etc., are taken by the Principal. The limited risk 13 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
distributor merely executes strategy and receives guaranteed returns and cannot incur any losses.
32. In our considered opinion, actual transaction entered into between assessee and its A.E. is to be considered for determining MAM to compute the ALP.
Section 92 (1) of the act provides that:
"Any income arising from an international transaction shall be computed having regard to the arms length price.
The procedure for computation of arms length price has been set out in section 92C (1) which provides that "the arms length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the board may prescribe.
The 5 specific methods have been enshrined in this provision apart from one general method, being: "Such other method as may be prescribed by the board"
Rule 10B(1) of Income Tax Rules, 1962, says that for purposes of Section 92C(2), ALP shall be determined by any one of the five methods, which is found to be the most appropriate method, and goes on to lay down the manner of determination of ALP under each method. Rule 10B(1)(b) recognizes Resale Price Method(RPM), as the method for determining ALP in relation to an international transaction where the price at which the property is purchased is resold to a customer, without there being any value addition in the product resold. There is a specific 14 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
method that is used to determine ALP of International transaction under such circumstances.
As the issue involved for consideration is in respect of MAM for determination of ALP, it will be useful to first set out modus operandi of RPM, being method given under Rule 10B(l)(b),used in case of a distributor/Trader as under:--
Resale Price Method, by which,--
(i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified;
(ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions;
(iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services;
(iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market;15
ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
(v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise;
Sub-clause (i) of clause (b) of Rule 10B(1) deals with identifying price at which goods are purchased from AE is resold;
Sub-clause (ii) of clause (b) of Rule 10B(1) talks of reducing amount of normal gross profit margin of comparable uncontrolled transactions from such resale price of assessee; Sub-clause (iii) states that result of sub-clause (ii) is further reduced by expenses incurred in connection with purchase of goods; and sub-clause (iv) provides that amount so deduced under sub- clause (iii) is adjusted on account of differences in international transaction and comparable uncontrolled transactions which materially affect amount of gross profit margin in open market; Finally, sub-clause (v) provides that the adjusted price found under sub-clause (iv) is taken as arm's length price in respect of purchase of goods from the AE.
33. When we consider the methodology given under RPM, more specifically sub-clauses (i) and (v), it becomes patent that sub- clause (i) refers to property purchased by assessee is resold and sub-clause (v) refers to 'arm's length price in respect of purchase of property by enterprise. A close scrutiny of above two sub- clauses along with remaining sub-clauses of rule 10B(l)(b) makes it clear beyond doubt that RPM is best suited for determining ALP of an international transaction in the nature of purchase of goods 16 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
from an AE, which are resold as such to unrelated parties. Ordinarily, this method pre-supposes no or insignificant value addition to the goods purchased from foreign AE.
34. Only in case where goods so purchased are used either as raw material for manufacturing finished products or are further subjected to processing before resale, or when there are other huge expenses incurred by assessee then RPM cannot be characterized as a proper method for benchmarking international transaction of purchase of goods by the Indian enterprise from the foreign AE.
35. The Organization for Economic Co-operation and Development ('OECD', for short) has laid down "transfer pricing guidelines" for Multi-National Enterprises and Tax Administrations. These guidelines give an introduction to the arm's length price principle.
Article 9 of model convention deals with Principle of arm's length and provides guidelines for "recognition of the actual transactions undertaken" in paragraphs 1.36 to 1.41. Paragraphs 1.36 to 1.38 are important and are relevant to our purpose. These paragraphs are re-produced below: -
"1.36 A tax administration's examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as these are consistent with the methods described in Chapters II and III. In other than exceptional cases, the tax administration should not disregard the actual transactions or substitute other transactions for them. Restructuring of legitimate business 17 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured.
1.37 However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises where the economic substance of a transaction differs from its form. In such a case the tax administration may disregard the parties' characterization of the transaction and re-characterise it in accordance with its substance. An example of this circumstance would be an investment in an associated enterprise in the form of interest-bearing debt when, at arm's length, having regard to the economic circumstances of the borrowing company, the investment would not be expected to be structured in this way. In this case it might be appropriate for a tax administration to characterize the investment in accordance with its economic substance with the result that the loan may be treated as a subscription of capital. The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price. An example of this circumstance would be a sale under a long-term contract, for a lump sum payment, of unlimited entitlement to the 18 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
intellectual property rights arising as a result of future research for the term of the contract (as previously indicated in paragraph 1.10). While in this case it may be proper to respect the transaction as a transfer of commercial property, it would nevertheless be appropriate for a tax administration to conform the terms of that transfer in their entirety (and not simply by reference to pricing) to those that might reasonably have been expected had the transfer of property been the subject of a transaction involving independent enterprises. Thus, in the case described above it might be appropriate for the tax administration, for example, to adjust the conditions of the agreement in a commercially rational manner as a continuing research agreement.
1.38 In both sets of circumstances described above, the character of the transaction may derive from the relationship between the parties rather than be determined by normal commercial conditions as may have been structured by the taxpayer to avoid or minimize tax. In such cases, the totality of its terms would be the result of a condition that would not have been made if the parties had been engaged in arm's length dealings. Article 9 would thus allow an adjustment of conditions to reflect those which the parties would have attained had the transaction been structured in accordance with the economic and commercial reality of parties dealing at arm's length."
36. At this juncture, we note mandate of Rule 10C which defines the 'Most appropriate method'. Sub-rule (1) of Rule 10C states that:
"For the purposes of sub-section (1) of section 92C, most appropriate method shall be the method which is best suited to the 19 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
facts and circumstances of each particular international transaction, and which provides most reliable measure of an arm's length in relation to the international transaction."
37. Now once again at the cost of repetition, we advert to functions performed by assessee. It is admitted fact that assessee simply purchase products from its AE's and is resold without any further value addition. Assessee has cataragorised itself to be low risk bearing entity. There is no dispute regarding very minimal risk/no risk withstood by assessee on the basis of low intensity function performed by it. The product imported from AEs representing international transaction, is neither processed further, nor used as raw material for manufacturing any other product. Thus on the basis of legal position enumerated hereinabove, in our considered opinion RPM has to be the most appropriate method to determine ALP of transaction having regard to the arrangement between assessee and the AE of simple purchase and sale of product without having any value addition by assessee.
38. Thus, we are inclined to uphold APM to be the MAM for determining ALP of transaction.
39. Once it is held, RPM to be the most appropriate method, comes the turn of AO/TPO/DRP to satisfy himself that not only correct method has been applied by assessee but also that proper data for determination of a repeat under such method has been made available. Admittedly, comparables proposed by assessee and used by Ld.TPO/AO/DRP for purposes of analysis, do have significant intensity functions, as compared to that of assessee. Ld.AO/TPO/DRP overlooked these huge differences between low 20 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
risk function performed by assessee vis-a-vis high intensity functions performed by comparables which is not acceptable when RPM is used as MAM.
40. We are thus of opinion that Ld.AO/TPO erred in not conducting fresh search of comparables which would have strict functional similarity while using RPM as MAM.
41. Before DRP assessee took alternative plea regarding data available for purposes of applying RPM to compute arm's length price of international transaction. Assessee provided details of comparables in the form of additional evidence before DRP. However DRP did not admit these details/evidences and upheld the action of Ld. AO/TPO.
42. In our considered opinion, Ld.TPO erred in not conducting fresh search of comparables for purposes of determining the comparability of the arm's length price by using RPM as MAM. Further before DRP even after assessee having submitted additional evidence in relation to fresh comparables for determining ALP by using RPM as most appropriate method was rejected.
43. Sub-rule (2) of Rule 10C lists certain factors which should be taken into account in selecting most appropriate method, as specified in sub-rule (1). These factors, inter alia, include '(c), the availability, coverage and reliability of data necessary for application of the method'; and '(d) the degree of comparability existing between the international transaction and the uncontrolled transaction. . .. . . . .' 21 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
44. Ground No.2.9 Before us apart from arguing for application of TNMM as most appropriate method, assessee vide Ground 2.9 has taken alternate plea to consider the fresh search of comparables submitted by assessee as additional evidence for applying RPM. While doing so, Ld.Counsel referred to page 139 of appeal sets wherein gross profit margin of new comparables selected by assessee for applying RPM as most appropriate method has been listed. It was submitted by assessee before DRP that these comparables have similar functional intensity as that of assessee and are operating in Automation industry. It has also been submitted that the margin ranges between 2.72% to 6.26% with an arithmetic mean of 4.71% vis-a-vis the gross profit margin of assessee at 5.69%. It has been submitted therein that the functions of these comparables are similar to that of assessee and does not assume any risks subject to any kind of adjustments that may be required. None of the above has been verified by DRP.
45. We therefore set aside this issue to Ld.TPO/AO with following directions:
(1) To adopt RPM as most appropriate method for determining ALP of transaction relating to Import of products from A.E. (2) To admit additional evidence filed by assessee regarding fresh set of comparables for determining ALP of transaction by using RPM.
(3) DRP is directed to decide issue as per law by giving proper opportunity to assessee.
Assessee is directed to file all necessary details regarding comparables sought to be relied upon for determining ALP of 22 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
transaction by using RPM. Ld.TPO/AO then shall take all necessary steps as per law to ascertain comparability of comparables so relied upon by assessee.
46. Accordingly we allow alternate plea raised by assessee in Ground No.2.9 for statistical purposes and dismiss ground nos. 2 to 2.8 and 2.10 to 2.12.
47. Ground No. 3 to 3.5 relates to adjustment of Rs.52,22,479/- on account of difference in the ALP of the international transaction of receipt of localisation support.
48. Ld.Counsel drew our attention to the agreement (supra) entered into between assessee and the AE to submit that payment of Rs. 52,22,479/- have been made for provisions of guidance and consultancy on drawings, design and quality perspective in respect of localised material. Ld.Counsel submitted that assessee is responsible for localization of the imported components/products having regard to Indian customer's requirements. He submitted that due to stringent quality measures and criticality of products, the localisation activity undertaken by the assessee is very limited and only a small percentage of items are localised.
49. Ld.Counsel further submitted that complete process of localisation is divided into three broad steps, namely, process for selection of suppliers, certification process and approval process. He explained that AEs role is critical at every step of localisation. It was further contended that royalty is paid by assessee in consideration for technology provided and licence granted by the AE for manufacture of goods and same cannot be regarded as consideration for the support/services provided by the AE for 23 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
separate customisation/localisation of components. Ld.Counsel stated that concept of benefit test is not relevant and Ld.TPO cannot say that the assessee was in need of the services and, therefore, no further payment was necessary.
50. Ld.Counsel stated that there is no bar under the Act to have transaction with group companies and the assessee is free to conduct business in the manner most suitable to it and commercial or business expediency of incurring any expenditure is to be seen from the assessee's point of view. Ld.Counsel concluded by stating that it is not correct to hold that payment of localisation support charges is duplication of expenditure.
51. On the contrary, Ld.CIT DR strongly supported the findings of the TPO and read the relevant observations of the TPO.
52. We have perused the submissions advanced by both the sides in the light of the records placed before us.
53. It is observed that the Ld. TPO while making adjustment on this issue, held that no separate compensation is required as these services are included in technology transfer and patent licence agreement and, therefore it is duplication of expenditure. The assessee has not been able to prove that the services were actually received and has grossly failed to satisfy need, benefit and evidence of the services. In our view it is a settled law that a businessman has prerogative to organise his affairs in the manner best suited to its functioning, commercial or business expediency. Revenue authorities cannot step into their shoes. Thus assessee cannot be directed by the revenue authorities, of how to conduct its business. Hon'ble Delhi High Court in the case of CIT versus Cashman and Wakefield (India) Pvt Ltd., reported in 24 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
(2014)2 46 Taxmann.com 317 has held that ,TPO is to conduct transfer pricing analysis determined the ALP and not to determining whether the taxpayer derives benefit from any services or not.
54. Respectfully following the afore stated decisions we reject the benefit test applied Ld. TPO.
55. On careful perusal of the agreement (supra), it is observed that supply of know-how and training by AE is to the suppliers and not to assessee. In our considered opinion, it cannot be said that such expenditure is subsumed with royalty agreement. Ld.TPO was required to simply determine ALP of transaction, unconnected with the fact, of any benefit that is accrued to assessee. Ld.AO/TPO/DRP has acted contrary to ratio laid down by Hon'ble High Court in case of Cushman & Wakefield India (Pvt.)(Ltd.) (supra). We accordingly set aside the issue to Ld.AO/TPO for deciding this issue within broader parameters laid down by Hon'ble Delhi High Court in case of Cushman & Wakefield India (Pvt.)(Ltd.) (supra).
Accordingly Ground No. 3-3.5 raised by assessee stands allowed for statistical purposes.
56. Ground No. 4 to 4.5 relates to disallowance of Rs.2,57,43,018/- on account of royalty paid to AE under royalty agreement.
57. At the outset Ld.Counsel submitted that the issue stands squarely covered in assessee's own case by order passed in the preceding Assessment Year. He might have drew our attention to the decision of Co-Ordinate Bench vide order dated 19.10.2016 for Assessment Years 2008-09 and 2009-10 in ITA Nos. 1267 & 25 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
5884/Del/2014.
58. Ld.CIT DR, though relied upon the finding of the lower authorities but could not bring any distinguishing decision in favour of the Revenue.
59. We have perused submissions advanced by both sides in the light of records placed before us. We have also perused order passed by Co-Ordinate Bench of this Tribunal in assessee's own case for preceding Assessment Years relied upon by Ld. Counsel. We find force in the contention of the Ld.Counsel for the assessee. Similar issue was considered by Co-Ordinate Bench (supra) , wherein identical disallowance made has been deleted. This Tribunal observed as under:
"6. We have carefully considered the submissions of both the sides and have perused the material placed before us. We find that the Revenue has accepted the royalty as revenue expenditure in the preceding as well as subsequent years. Thus, there would be no justification for treating the same to be capital expenditure in some of the intervening years. Hon'ble Apex Court in the case of Radhasoami Satsang Vs. CIT - [1992] 193 ITR 321 held as under:-
"Held, reversing the decision of the High Court, on the facts, (i) that property given to the Satguru was intended for the common purpose of furthering the purpose of the institution. The central council had authority to manage the properties of the institution and, on revocation of the trust, the property was not to go back to the Satguru, and, at the most, in the place of the trust, the central 26 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
council would exercise authority. The Tribunal was justified in holding that the properties were subject to a legal liability of being used for the religious or charitable purposes of the Satsang.
(ii) That, in the absence of any material change justifying the Department to take a different view from that taken in earlier proceedings, the question of the exemption of the assessee assessee should not have been reopened.
Strictly speaking, res judicata does not apply to income- tax proceedings. Though, each assessment year being a unit, what was decided in one year might not apply in the following year; where a fundamental aspect permeating through the different assessment years has been found as a fact one way or the other and parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year."
5 ITA-1267 & 5884/D/2014
7. The ratio of the above decision would be squarely applicable to the facts of the assessee's case. Moreover, Hon'ble Delhi High Court in the case of CIT Vs. G4S Securities System (India) P. Ltd. (supra), held as under :-
"Held, dismissing the appeals, that the ownership rights of the trade mark and know-how throughout vested with the foreign company and on the expiration or termination of the agreement the assessee was to return 27 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
all the know- how obtained by it under the agreement. The payment of royalty was also to be on year to year basis on the net sales of the assessee and at no point of time was the assessee entitled to become the exclusive owner of the know-how and the trade mark. Hence, the expenditure incurred by the assessee as royalty was revenue expenditure and was deductible under section 37(1) of the Income-tax Act, 1961."
8. The ratio of the above decision would be squarely applicable to the facts of the assessee's case because the payment of royalty in the case of the assessee is also on year to year basis on the net sales of the assessee and at no point of time, the assessee is entitled to become the exclusive owner of know-how and the trademark. We also find that in assessment year 2011-12, the DRP, after considering the agreement and legal position in detail, held as under:-
"Perusal of the extracts from the agreement does not reveal to us that any secret or process of manufacture is sold so as to be construed to be capital in nature. Limited non-exclusive, non transferable rights to manufacture, use, or sell all licensed products under licensed patents and licensed know-how in licensed territory are obtained by taxpayer in lieu of payment of royalty for the term of the agreement which is 7 years. There is a prohibition on parting with confidential information and creation of further rights in favour of third parties. What is accorded is purely access to technical knowledge which is for the tenure of the agreement. DRP has also noted a recent decision of the Advanta India Ltd. (TS 590-HC-2015 (TEL&AP) wherein the Hon'ble High Court has distinguished Alembic Chemical Works and held in favor of capitalization 6 ITA-1267 & 5884/D/2014 of ¼ of payment for know-28
ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
how only as capital in nature, on facts where the taxpayer acquired a living organism "germplasm" used to produce revenue generating products. But, even here the royalty paid was confirmed as a revenue expense. Having examined the Agreement governing Royalty, and the terms of its payment in light of the principles laid down by the Supreme Court and High Court and in due deference to decisions in the case of Alembic Chemical Works Co Ltd v CIT, 177 ITR 377 (SC) supra and Delhi High Court in the case of CIT v JK Synthetics Ltd 309 ITR 371, Shri Refrigeration Industries Ltd v CIT 127 ITR 746, Triveni Engr Works Ltd v CIT 136 ITR 340 Ciba of India 69 ITR 692 Hon'ble Supreme Court and other DRP concludes that royalty paid is revenue in nature. AO is directed to allow it accordingly."
9. The above decision of DRP has been accepted by the Revenue and has become final. In view of the above, we do not find any infirmity in the order of learned CIT(A). The same is upheld and the appeals filed by the Revenue are dismissed.
It has been submitted by Ld.Counsel that Assessing Officer, in the immediately succeeding A.Y. viz., 2011-12, had proposed identical disallowance by treating the royalty expenditure as capital expenditure in the draft assessment order dated 12.02.2015, which was challenged by assessee before DRP. The DRP, after due consideration of various clauses of agreement as well as legal position, observed that assessee had not acquired any intangible asset and agreement merely accorded access to technical know-how during the tenure of agreement. Accordingly, DRP directed AO to delete aforesaid proposed disallowance. In pursuance thereto, AO, vide final assessment order dated 25.01.2016 deleted disallowance proposed on identical basis.
29ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
Ld.Counsel further invited our attention to order dated 16.03.2016 passed by A.O. in assessee's own case for Assessment Year 2012-13 wherein no disallowance on aforesaid issue was made, duly substantiating that revenue authorities have also accepted fact that payment of royalty expenditure was an allowable business deduction. Copies of the respective orders are placed in the paper book at pages 885-887 and 893-894 respectively of index case law-II.
60. We have perused the agreement as per which the royalty payment has been made by assessee to the AE, which was also applicable for preceding Assessment Years. Facts being same and the transaction being identical, we do not find any reason to differ with the afore stated observations by the Co-Ordinate Bench in the preceding Assessment Years. Respectfully following the same we delete the disallowance made by Ld.AO/TPO. Accordingly Ground No. 4 -4.5 raised by assessee stands allowed.
61. In the result, appeal filed by assessee stands partly allowed. The order is pronounced in the open court on 29.10.2018.
Sd/- Sd/-
(N.K. BILLAIYA) (BEENA A PILLAI)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated: 29th October, 2018
*GMV
30
ITA 312/Del/15 AY : 2010-11
Mitsubishi Electric Automotive India P Ltd.
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(A)
5. DR Asst. Registrar, ITAT, New Delhi 31 ITA 312/Del/15 AY : 2010-11 Mitsubishi Electric Automotive India P Ltd.
Date
1. Draft dictated on
2. Draft placed before author
3. Draft proposed & placed before the second member
4. Draft discussed/approved by Second Member.
5. Approved Draft comes to the Sr.PS/PS
6. Kept for pronouncement on & Order uploaded on :
7. File sent to the Bench Clerk
8. Date on which file goes to the AR
9. Date on which file goes to the Head Clerk.
10. Date of dispatch of Order.32