Income Tax Appellate Tribunal - Delhi
Lumax Industries Ltd., New Delhi vs Department Of Income Tax on 30 September, 2010
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH : I : NEW DELHI
BEFORE SHRI G.D. AGRAWAL, HON'BLE VICE PRESIDENT
AND
SHRI A.D. JAIN, JUDICIAL MEMBER
ITA No.4715/Del/2010
Assessment Year : 2004-05
ITA No.6086/Del/2010
Assessment Year : 2005-06
DCIT, Vs. Lumax Industries Limited,
Circle 4(1), Room No.407, B-86, Mayapuri Industrial Area,
CR Building, IP Estate, Phase-I,
New Delhi. New Delhi.
PAN : AAACL1126D
(Appellant) (Respondent)
Assessee by : Shri Pradeep Dinodia,
Shri R.K. Kapoor and
Miss Pallavi Dinodia, CAs
Revenue by : Shri Peeyush Jain, CIT, DR
ORDER
PER A.D. JAIN, JUDICIAL MEMBER
ITA No.4715/Del/2010
This is an appeal filed by the department for Assessment Year 2004-05 against the order dated 30.09.2010 passed by the CIT (A)-XX, New Delhi, taking the following effective grounds:-
"2. On the facts and in the circumstances of the case and in law, the Ld. CIT (Appeals) has erred in deleting the addition of Rs.2,27,23,781/- made by the A.O. for calculating the book profit being the provision for retirement benefits.2 ITA Nos.4715 & 6086/Del/2010
2.1 The learned CIT (Appeals) has ignored the fact that the assessee itself had added the sum in question to its income for computing the taxable income.
3. On the facts and in the circumstances of the case and in law, the ld. CIT (Appeals) has erred in deleting the addition of Rs.2,51,88,406/- made by the A.O under section 92CA of the Act being the TPO adjustment.
3.1 The ld. CIT (A) ignored the fact recorded by the TPO and also the fact that amount of royalty paid and excess amount paid on purchases has also been ignored.
4. On the facts and in the circumstances of the case and in law, the ld. CIT (Appeals) has erred in deleting the addition of Rs.2,59,434/- made on account of foreign tour of the director of the company."
2. Ground No.1 is general.
3. Ground No.2 challenges the action of the Ld. CIT (A) in deleting the addition of ` 2,27,23,781/- made by the Assessing Officer for calculating the book profit, being the provision for retirement benefit. The Assessing Officer observed that in respect of computation of book profit u/s 115JB of the IT Act, the assessee has not offered any explanation in respect of provision of ` 2,27,23,781/- for retirement benefit. The Assessing Officer observed that this expenditure was a contingent liability for the future, calling for adjustment to be made under Explanation (c) to Section 115JB (2) of the Act. The Assessing Officer made addition of this amount of ` 2,27,23,781/-.
4. The Ld. CIT (A) having deleted the addition, the department has taken ground No.2 before us.
5. The Ld. DR contended that the Ld. CIT (A) has erroneously deleted the addition correctly made by the Assessing Officer on account of calculation of book profit being the provision for retirement benefits; that while doing so, the Ld. CIT (A) has illegally ignored the 3 ITA Nos.4715 & 6086/Del/2010 fact that the assessee had itself added the amount in question to its income for computing the taxable income.
6. The ld. counsel for the assessee, on the other hand, has contended that in the computation of income under the normal provisions of the Act, the assessee had offered this amount u/s 43B (f); that under the said Section, provision for leave encashment is allowable only on payment basis; and that however, from this, it cannot be inferred, as had wrongly been done by the Assessing Officer, that the liability was either contingent, or had not accrued.
7. The Ld. CIT (A), it is seen, in deleting the addition, has gone by 'Apollo Tyres Ltd. vs. CIT', 255 ITR 273 (SC) and 'Bharat Earth Movers vs. CIT', 245 ITR 428 (SC), besides other case laws cited by the assessee. In 'Apollo Tyres' (supra), the Hon'ble Supreme Court held that the Assessing Officer has limited powers to examine as to whether the books are certified by the authorities under the Companies Act and are properly maintained; and that the Assessing Officer has no power to go behind the net profit declared, except to the extent provided in the Explanation to Section 115J of the IT Act. In 'Bharat Earth Movers' (supra), the Hon'ble Supreme Court held that if a business liability has definitely arisen in the accounting year, the deduction should be allowed, albeit the liability may have to be quantified and discharged at a future date; that it should also be capable of being estimated with reasonable certainty, though the actual quantification may not be possible; and that the difference between accrued and contingent liability set apart to meet the liability on account of leave encashment of employees is not a contingent liability, and is, accordingly, deductible u/s 37(1) of the IT Act.
4 ITA Nos.4715 & 6086/Del/20108. The Finance Act, 2001 inserted clause (f) in Section 43B of the Act. As per this clause (f), the expenses of leave encashment are allowable on an actual payment basis. No corresponding amendment, however, was brought about in Section 115JB of the Act, with the result that the provisions for expenses accrued and ascertained shall be allowed while computing book profits under MAT. As such, provision for retirement benefit in the computation of book profits u/s 115JB of the Act is to be allowed, if such provision for retirement benefits has been made on a scientific basis. Now, in the case of the assessee, as even accepted by the Assessing Officer himself in the assessment order (in para No.6 thereof), the computation of retirement benefits, having been made on the basis of actuarial valuation, is based, undoubtedly, on a scientific basis. Such provision is not a contingent liability and the liability accrues from the moment an employee is hired and starts rendering services. Only the payment of the dues is deferred, which does not amount to a contingent liability. As such, the Ld. CIT (A) has correctly held that the provision for retirement benefit, as duly certified by the actuarial valuation, cannot be treated as a contingent or unascertained liability and it is a definite liability in presenti, which is to be discharged at a future date.
9. The Ld. CIT (A), therefore, has correctly deleted the addition. Accordingly, ground No.2 is rejected.
10. So far as regards ground No.3, the TPO made an adjustment of ` 2,51,88,406/- on account of difference in arm's length price of international transaction of payment of royalty and purchase of raw materials and value of international transaction. The assessee maintained that in the earlier years, the department had disallowed only 25% of the royalty paid to Stanley Electric Company, Japan and others, on account of capital nature, whereas for the year under 5 ITA Nos.4715 & 6086/Del/2010 consideration, the TPO had disallowed the entire amount of royalty paid to Stanley without considering the facts of the case; that there were no comparables in respect of royalty; and that even before Stanley became an associate enterprise of the assessee in 1994, the assessee company had been paying the royalty @ 3% of sales to this company. Apropos royalty paid to Rober Bosch Gmbh, Germany at ` 1,20,796/- and M/s Value Vision, France at ` 7,80,379/-, both @ 4% on sales, the assessee submitted that it had obtained technical assistance and knowledge for manufacture of Ford Ikon head lamp and tail lamp; that there was an agreement with these companies, approved by the RBI for payment of royalty; and that this was not a capital expenditure, as the expenditure had been incurred for technical know-how, which was a fast changing process. On considering the stand of the assessee, the Assessing Officer made an adjustment of ` 2,51,88,406/- u/s 92CA of the IT Act, on the basis of TNMM analysis.
11. By virtue of the impugned order, the Ld. CIT (A) deleted the addition made.
12. Challenging the impugned order in this regard, the Ld. DR has contended that the Ld. CIT (A) has erred in deleting the addition of ` 2,51,88,406/- correctly made by the Assessing Officer u/s 92CA of the Act, being the TP adjustment; that while doing so, the Ld. CIT (A) has ignored the facts recorded by the TPO and also the fact about the amount of royalty paid and the excess amount paid on purchases; that the royalty was correctly treated by the TPO as unjustified; that the agreement for payment of royalty was a mere paper document; that Stanley had provided full time expatriate employees/qualified engineers to the assessee company and, therefore, there was no need for the assessee to receive any further technology; that the claim of the assessee that engineers, etc., visited Japan for getting trained in 6 ITA Nos.4715 & 6086/Del/2010 the technology, was not correct; that since the assessee had made purchases of moulds and designs to the tune of ` 1 crore, further technology was not required, because apart from the moulds and designs, the assessee had also purchased raw material such as bulbs, sockets, lenses, etc.; that in fact, there had not been any actual receipt of technology by the assessee company from Stanley; that all this had duly been taken into consideration by the TPO while making the adjustment; and that the Ld. CIT (A) has erred in brushing aside the observations made by the TPO. Besides, the Ld. DR has reiterated the arguments adduced while dealing with a similar issue concerning royalty, in the assessee's case for Assessment Year 2008-09 in the assessee's appeal in ITA No.4456/Del/2012 (which we have disposed of vide our order dated 31.05.2013).
13. The ld. counsel for the assessee, on the other hand, also reiterating the arguments raised in the assessee's appeal for Assessment Year 2008-09 (supra), has made further verbal arguments. A written synopsis/submissions have also been filed.
14. The arguments raised in the assessee's case for Assessment Year 2008-09 (supra) have been heavily relied on. It has been contended that the assessee had been paying royalty to Stanley from 1984 and the same was allowed by the department upto Assessment Year 2003-04; that for Assessment Years 1984-85 to 1993-94, the royalty was allowed as a 100% revenue expenditure by the Assessing Officer himself; that for Assessment Years 1994-95 to 1999-2000, the payment of royalty was allowed as a bona fide payment, whereas 25% thereof was capitalized; that on appeal, the Hon'ble Delhi High Court, vide its decision, reported at 173 Taxman 390 (Del), has held that the payment of royalty was on the basis of a bona fide business need and that the same represented revenue expenditure; that the royalty 7 ITA Nos.4715 & 6086/Del/2010 agreements, right from Assessment Year 1984-85, till Assessment Year 2004-05, are the same agreements; that in Assessment Year 2003-04, Stanley was a 19.41% shareholder with the assessee and it acquired the status of an AE of the assessee in Assessment Year 2003-04; that the TPO made an adjustment concerning royalty payment, failing to consider that the royalty was being paid by the assessee only on the products being produced under license from Stanley and not on items manufactured and sold under the assessee's own brand; that the TPO further failed to consider that since the corporate tax rates in Japan are much more than those in India, there was no reason whatsoever for the assessee to shift the income; that the TPO had erred in observing that the agreement of the assessee with Stanley was a mere paper document; that the TPO had erred in observing that since Stanley had provided full time expatriate employees/qualified engineers to the assessee, there was no need for the assessee to receive any further technology, whereas these personnel had been sent to the assessee by Stanley only because of the commercial relationship between them for providing technology, for which it was, that the royalty was paid; that the TPO had further erred in observing that the assessee's claim of engineers, etc., having visited Japan for training in the technology, was false, whereas this claim of the assessee stood factually established on record; that the TPO had also erred in observing that the assessee having made purchases of moulds and designs and raw material like bulbs, sockets, lenses, etc., to the tune of ` 1 crore, no further technology was required by the assessee, failing to consider that it was in order to put to use such moulds, designs and drawings, that the technology was required, for which, the royalty had been paid; that the TPO had further erred in observing that there had been no actual receipt of technology by the assessee; that whereas the assessee had justifiably applied the CUP method to the royalty payment, the TPO had erred in disregarding the application of the CUP method, without 8 ITA Nos.4715 & 6086/Del/2010 assigning any cogent reason for such disregard; that the TPO had erroneously applied the TNMM and recommended upward adjustment of ` 2,03,02,776/-, which was wrong in the event of internal CUP having been available; that the TPO had wrongly rejected all the comparable companies selected by the assessee in its TP study, retaining only one, i.e., Phoenix Lamps Ltd.; that in such rejection, Rule 10B (2) of the Rules was not followed by the TPO; that apropos all the five companies rejected by the TPO as comparables, no FAR analysis was done by the TPO, even though such FAR analysis is essential for establishing comparability between the tested party and the other companies chosen for benchmarking the ALP, as held in the case of 'Aztec Software', 294 ITR (AT) 32 (Bang); that the Ld. CIT (A) has correctly concluded that the sole comparable selected by the TPO was not a proper comparable, since it was operating in an SEZ, requiring certain adjustments, rendering it unfit for comparison with the assessee in the absence of such adjustments as per Rule 10B (3) of the Rules; that while rejecting/selecting comparable companies, the only criterion adopted by the TPO was turnover, which is not envisaged as a criterion by Rule 10B(2); that the ratios used by the TPO were extraneous to the TP Regulations; that Phoenix Lamps having a different product line from that of the assessee, was not a proper comparable under Rule 10B(2) of the Rules, even though this company had initially been selected by the assessee itself as a comparable in its TP study and had, at the assessment stage, requested this company to be rejected as a comparable, or for adjustment in the PLI thereof to be made; that the TPO had further failed to consider that for Assessment Year 2006- 07, the TPO had himself rejected Phoenix Lamps as a comparable; that whereas the TPO took only one comparable, i.e., Phoenix Lamps, the Ld. CIT (A) has correctly taken the three comparables, i.e., Indian Japan Lighting, Fiam Industries and Jagan Lamps Ltd., as the proper comparables and finding the PLI of these three comparables to be 9 ITA Nos.4715 & 6086/Del/2010 lower than the PLI of the tested party, the assessee (4.26% as against 6.50%), the Ld. CIT (A) has correctly deleted the addition made on account of ALP; and that alternatively, even if Phoenix Lamps were to be retained as a comparable along with the other three comparables accepted by the CIT (A), the average PLI of the comparables including Phoenix would be 6.44%, warranting no addition on account of ALP, either on account of royalty, or on account of purchases of raw material.
15. Having heard the rival contentions on this issue with regard to the material available on record, it is seen that the CIT (A) deleted the addition of ` 2,51,88,406/- made by the Assessing Officer u/s 92CA of the Act, on account of TP adjustment, by observing as follows [it is for the sake of ready reference that this elaborate order of the CIT (A) on the issue at hand is being reproduced here]:-
"TRANSFER PRICING ISSUE The second issue in this appeal has been raised vide ground nos. 2(a) 2(b) and 2(c) as reproduced above, pertains to the addition made by the AO based on the order passed by the Tranfer Pricing u/s 92CA(3) of the Income-tax Act, on account of adjustment of arms' length price amount to Rs. 2,51,88,406/-.
The AO has discussed this issue in para 7 onwards in his order.
The appellant has submitted that during the course of the assessment year under consideration it had undertaken the following international transactions with its AEs and the TPO has made adjustment against such transactions as given below:-
Sl.No. Particulars Transactions Adjustment Arm's length by TPO (Rs.) Price as per TPO (Rs.) 1 Import of raw material, 6,44,55,527/- 48,85,630/- 5,95,64,897/-
spares and components 2 Purchase of Moulds/ 62,50,907/- NIL 62,50,907/-
Machinery 3 Payment of Royalty 2,03,02,776/- 2,03,02,776/- NIL 4 Purchases of Design & 33,18,000/- NIL 33,18,000/-
Drawings Total 9,43,22,210/-
9,43,22,210/- 2,51,88,406 10 ITA Nos.4715 & 6086/Del/2010 It is further submitted by the appellant that the TPO has recommended adjustments in the arms' length price pertaining to transactions at serial no. 1 & 3 i.e. value of Import of raw material, spares and components amounting to Rs. 48,85,630/- and payment of royalty of Rs. 2,03,02,776/- and he has accepted the other two international transactions pertaining to purchase of moulds and machinery and purchase of design and drawings. It has further been submitted that, though the TPO has discussed at length about the payment of royalty amounting to Rs. 2,03,02,776/-, however while recommending the final adjustment he has determined the arms' length price on an overall basis under TNMM.
(i) The appellant has submitted that in the in the ever changing competitive world every person is striving hard for increasing its market share by introducing new technology in its manufacturing process.
(ii) That the Automotive industry is one of the fastest growing industries in India, with its rapidly changing technology and the frequent introducing of new models of vehicles. It is an established fact that Japan and Germany are world leaders in automotive technology and best practices. Most Indian companies have entered into Joint ventures, partnerships and/ or collaborations with foreign companies of these two countries. The trend is followed by most Indian companies, the foreign partner brings with him the advantage of technology which is superior as they are already ahead in their Research and Developmental activities. India being n emerging market where there is a huge demand of goods and services making this the natural choice for most of the foreign company to invest. The Technology provided by a foreign companies is slowly absorbed by the Indian partner, however, to keep pace with their constant advancement it usually needs constant up-gradation. The research and development for up-gradation of technology is done by the foreign partners, who usually have specific R & D Centers set up in their home countries for these activities.
(iii) That the appellant is engaged in the business of manufacturing and trading of lighting products for the automotive industry. This industry is which the assessee operates is a highly competitive one, technology and skilled work-force are the two most necessary pillars of being able to manufacture and sell in this market.
11 ITA Nos.4715 & 6086/Del/2010(iv) That the foreign partner brings with him intangible value both in terms of technology as well as its brand/goodwill which adds to the commercial expediency of the Indian counterpart. The industry is structured in such a way in India, that the whole range of consumers and suppliers in the industry from the automakers to the auto-ancillaries, are all joint ventures and / or foreign collaborations or partnership with foreign companies. The Brand/ goodwill created by the foreign partner is his home country and/ or the world market turn into a Brand even for the Indian market. The consumers of the goods manufactured by the foreign partners of the Indian consumers of the same products in India. Thus, in the present case the assessee is able to sell the products it manufactures under the 'Stanley' brand name without undertaking much of the marketing efforts to the same companies' joint ventures/ collaborations in India who are Stanley's customers in its home market. Thus it is also humbly submitted that, the assess is not incurring substantial expenses on advertisement and sales promotion. The Stanley brand has enormous goodwill in the world market of the auto- industry, which assures all its consumers products of the highest quality and the latest technology and helps the assessee sell its products under the 'Stanley' brand at minimum cost and efforts.
It is important to note that the assessee has paid the royalty to the AE only on sales made by using the brand name, technology and know-how of AE's.
(v) That the TPO has raised objections as to why the royalty is being paid each year for the last about 20 years or so. In this regard, it is submitted that the period of 20 years should be viewed as a good stable partnership/ collaboration between the two companies which has assured the customers in India, of a should aegis and good relations. No consumers would want a relationship with parties which do not show good relations and stable foundations, which the period of 20 years signifies. Thus, by being a good aegis for the appellant even when the foreign partner was not an associate enterprise goes to show the support it lent by being a strong brand worldwide.
12 ITA Nos.4715 & 6086/Del/2010(vi) That a strong support by the Stanley brand in India, should in fact have led to an increase in rate of royalty after it becoming the AE of the appellant, which has in fact was not the case and the royalty was actually reduced showing signs of equity and parity between the two companies.
5. The appellant has further made submissions by highlighting the points made out by TPO in his order and countered the same as under :-
It has been submitted that as per the policy of the Government of India, these types of agreements require approval from the Reserve Bank of India and other Govt. Body on year to year basis, because the necessity and business needs of entering into such agreements are required to be examined by these authorities also.
It has further been claimed that agreement entered into either in writing or orally needs to be accepted by the TPO in view of Rule 10 B(2) (c) of the Income-tax Rule.
The appellant has also relied on the judgement in the case of Addl. CIT Vs Nestle India Ltd (2005) 94 TTJ 53 (ITAT), para 93, wherein it has been held as under:-
"We, find that the assessee's case is well armed in this respect on account of approval also granted by the RBI to the agreements in question. At any rate, from the facts stated and the evidence/material produced in the assessee's paper book, we are of the view that the technical assistance agreements in question were essential for the purpose of the business of the assessee during the assessment years before us. The assessee appears to have been highly benefited both in respect of profitability as well as growth of its business on account of close association and support from Nestle SA. Switzerland, internationally renowned and leading food processing company."
It has been claimed that in the appellants' case the rate of royalty has been reduced from earlier 4 % to 3 5 for the last few years. The appellant has applied to CUP method to justify the payment of royalty. Alternatively, the royalty payment was justified even under an overall analysis performed by the assessee under the TNMM method. The TPO has ignored all this vital information, ignored the provisions of transfer pricing, ignored the legal aspect (RBI & SIA approvals of the royalty payment and has attempted to decide the issue by saying that 13 ITA Nos.4715 & 6086/Del/2010 the payment was not required to be made or was not warranted. All the reasons adopted by A.O. / TPO to disallow the amount of royalty are of frivolous nature and are full of surmises and conjectures and in any case not warranted from the transfer pricing point of view.
(i) It has been submitted that while giving hypothetical examples the TPO had completely overlooked the facts of the assessee's case. Whereas there could be some element of practicability in the case studies given by the TPO in the case of 100 % subsidiary/ holding relationship, the same cannot be true where the concerned AE is just about 19.41 % stakeholder. It is not understood how and why a majority stakeholder (of 80.59%) would allow overpayments for the goods/services and would transfer his own profits to its foreign JV partner who is a minority stake holder (of 19.41% ). Infact, the facts of the assessee may prove to be contrary wherein the JV partner has perhaps put up an Executive Director to ensure that the business is conducted and carried out by accepting appropriate accounting norms and prudent business practices which are just and fair to all the business partners.
(ii) With regard to the observations of the TPO in para 6, page 6, of his order that since the assessee had employed full- time expert qualified engineers provided by Stanley Group of Japan, there is no need for receiving any technology, because the know-how is provided by such technical personnel. Their presence has great impact on the quality of the products manufactured by Lumax and for various technical discussions with engineers of the vendors who are both Indians and Foreigners. Such compensation to the AE could only be by way of payment of royalty. If the appellant was not paying any royalty for use of technology, even the arrangement of obtaining engineers would not have been provided. The appellant has claimed that, in fact, this aspect of the matter clearly demonstrated in favour of the appellant that the expats have been deputed by the AE on the rolls of the appellant.
14 ITA Nos.4715 & 6086/Del/2010(iii) Regarding to the observations of TPO at page 7, para 1 of his order that out of total 34 foreign visits, only one to two visits have been made and the claim of the appellant that engineers of the appellant visited countries is not correct. It has been submitted that the TPO has recorded incorrect facts with regards to this matter. It has been claimed that as per the definition of "associated enterprise" as contained in Section 92A(2) read with its various clauses other 100 % subsidiaries of Stanley Japan are also AE's of the appellant and the employees have made visits to the factories of those companies which are also AE's of the Stanley Japan. It has been claimed that out of thirty four visits ten visits were made to Japan, Tokyo and Thailand where the AE's of the assessee are situated. The purpose of the visits was getting the requisite training to enable them to apply the technology given by the AE and not for any other purpose. A commercially expedient company will not incur such expenses on the foreign visit of its employees with business necessity and sound reason. Hence, the contention of the Ld TPO is completely incorrect, it is re-iterated hat the visits of the engineers of the appellant were made for training purposes only and not otherwise.
(iv) The appellant has further submitted that the TPO's observation that since the assessee had purchased moulds, designs and drawings from the AE and apart from these, most of the material purchased are small items, such as bulbs, sockets, lenses etc. therefore, there was no further technology that may be required in manufacturing, are required to be rejected as surmises and conjectures. It has been claimed that merely import of these drawings, designs and moulds does not ispo- facto lead to situation that the appellant would also know how to make these designs. It has been claimed that if the view of the TPO are accepted, then primarily it would mean that by importing designs and moulds everybody become expert in manufacturing the items for which the designs and molds have been imported It has been explained that the manufacturing many item involves may more steps and stages and these observations of the TPO are away from the reality.
The international transactions entered with the AE's by the assessee are closely inter linked, hence the application of the 15 ITA Nos.4715 & 6086/Del/2010 TNMM on an overall margin analysis is justified. It would be pertinent to note that in the next ground raised by the TPO, he himself accepted that the aggregation of various international transactions is permissible as per Rule 10B. Therefore, it is prayed that his contention be dismissed.
(v) It has been submitted that reasons given by the TPO for rejecting the comparables found out by the assessee are not justified. Under the transfer pricing what is required to be seen is that whether the comparables selected ssatisfy the conditions envisaged under rule 10B(2) i.e. popularly known as FAR analysis.
(a) The specific characteristics of the property transferred:
(b) The functions performed, taking into aqccount the qassets employed and risks assumed.
(c) The contractual terms;
(d) Conditions prevailing in the markets in which the respective parties to the transactions operate keeping in view geographical locations, size of markets, the laws and government orders in force, overall economic development etc. etc. It has been submitted that all the comparables selected through a quantitative seach process by the assessee stood the test as under :
(1) All these comparables are in the business of manufacturing automotive lighting and equipments so the condition of rule 10B(2)(a) i.e. specific characteristics of property transferred is satisfied.
(2) All these comparables are the manufacturer of auto lighting equipments and are therefore performing the functions of typical manufacturing concerns. The assets employed for the manufacturing operations would depend, of course, on the size of turnover but essentially similar type of manufacturing facilities is involved.
However, a small manufacturer may not achieve economies of scale as a large manufacturer may, which may require some adjustments.
(3) The associated risks of manufacturing, risks of marketing are also identical. If auto market is booming every company would achieve higher.
(4) Two conditions prevailing in the market are identical because most of the sales are in the local markets by all the manufacturers. The geographical 16 ITA Nos.4715 & 6086/Del/2010 conditions, size of the market and laws of the government of India are same. However, it is in this category of laws of government that Phoenix Lamps Ltd. situated in SEZ and enjoying lower excise duty fell on aq different platform and which required either an adjustment in its PLI or a total rejection as has been done by the TPO himself in AY 2006-07 based on our similar submissions.
It has, therefore, been submitted that all the comparables rejected by the TPO is on certain extraneous factors such as low turnover which is not as per rules. Further, it has been claimed that if the TPO was to retain Phoenix Lamps Ltd., as a sole comparable, he should have carried out adjustment in accordance with rule 10B (1) (e) (iii) of the I.T. Rules. The reliance has been placed on the case of M/s Mentor Graphics (Noida ) Pvt Ltd., 109 ITD 101 (Del) for this proposition.
Further, the TPO while rejecting the companies has not performed any FAR analysis and has proceeded to make ad-hoc rejections of comparables chosen by the assessee on a well laid out and accepted basis.
(vi) Two other ratios i.e. Fixed Assets ratio and Inventory ratio calculated by the TPO should have been chosen to reject the Phoenix as a comparable. As the asset based of assessee is more than 150 % of the Phoenix, similarly, inventory ratio clearly indicates that assessee has to maintain stocks three times more than the Phoenix. These two ratios, which have some relevance to the FAR analysis clearly signal that functionally these two companies are not comparable. We have carried out some ratio analysis which has some meaning nd significance to FAR analysis with other comparables and the same is as under :-
Sl. Company's Year Fixed ROCE RONW
No. Name End Assets to (%) (%)
Turnover
1 Fiem Inds. Ltd 200403 2.38 19.71 10.25
2 Phoenix Lamps 200403 0.97 18.07 28.74
3 India Japan 200403 1.10 11.13 11.15
Lighting
4 Jagan Lamps 200403 1.07 1.63 1.44
5 Lumax Inds. 200403 1.69 12.83 18.00
(Sources : Capitaline Plus database)
17 ITA Nos.4715 & 6086/Del/2010
Hence, it has been submitted that TPO has adopted an approach in rejection of perfectly acceptable comparable companies is not valid. It has been submitted that companies as originally chosen by the assessee be accepted as comparable to the tested party.
(vii) Without prejudice to the above, it has further been submitted that the TPO has also compared the assessee with the single comparable selected by him i.e. Phoenix Lamps on the ratio parameter. The TPO accepted in his order that the fixed assets turnover ratio of the Phoenix Lamps are not in line with the assessee. The fixed-asset turnover ratio measures a company's ability to generate net sales from fixed-asset investments specifically property, plant and equipment (PP&E) - net of depreciation. A higher fixed-asset turnover ratio shows that the company has been move effective in using the investment in fixed assets to generate revenues. Hence, it is clear that the fixed assets ratio denotes the company's level of operation in relation to the assets deployed. Thus the contention of the assessee, that Phoenix Lamps should be rejected for the arm's length analysis should be accepted as neither is it a functionally comparable company nor does it has the same level of assets utilized for its business activities as the assessee.
(viii) During the course of hearing, it has been stated that the transactions of the assessee with its AEs have been benchmarked by the assessee under TMM Method for import of raw material and components, import of equipment and payment of royalty and resale price method in respect of international transactions related to import of drawing and design. As per Transfer Pricing Study, the assessee computed its net profit margin @ 6.5% and the average net profit margin of the comparable was computed @ (-) 0.5 % based on three years average. It was concluded that the Transactions undertaken by the assessee with its AE are on arms' length. However, during the course of proceedings, it has been submitted that only current year's data and information should be compared and not three years average which can be done only under certain eventualities, which is as per judgement of M/S Mentor Graphics Pvt Ltd Vs DCIT 109-ITD-101 (Del). Therefore, a revised chart was submitted vide letter dated 5th July, 2010 as under :-
18 ITA Nos.4715 & 6086/Del/2010SUMMARY OF WEIGHTED AVERAGE NPM S.No. Companies 2003-04 1 India Japan Lighting 8.17 % 2 Autolite India Ltd -10.79 % 3 Fiem Industries Ltd 2.69 % 4 Japan Lamps 1.91 % 5 Phoenix Lamps 12.97 % JMA Industries -34.36 % S.No. Average -3.24 % 1 Maximum 12.97 % 2 Upper Quartile 8.17 % 3 Median 2.69 % 4 Lower Quartile 1.91 % 5 Minimum -34.36 % From the above, it would be observed the average of the comparable compies worked out to be (-) 3.24 % as against (-) 0.05 based on three years average, which was given in Transfer Pricing Study. If Phoenix Lamps Ltd. is rejected, as has been submitted by assessee earlier, the average margin of balance 5 comparables for the current year would become (-) 6.4 % as against (+) 6.5 % of the assessee. Assessee has also filed the detailed working of the financials of all these comparable companies for the relevant assessment year only which have been sourced from the Capitaline data base and hence it is respectfully submitted that all these comparables had been included in the transfer pricing stage filed by the assessee and the Transfer Pricing Officer has rejected these comparables on analyzing certain ratios, these ratios have no basis and it is only the FAR analysis which is relevant for judging the arm's length price on the international transactions. At the time of filing the return and transfer pricing document, financial data for some of these comparables were not available and it is only an updated data for the current year which is relevant and which is being filed and to that extent there is no additional claim or evidence or comparable which has been filed before your honour. It was further stated by the assessee that again even if two companies given in the list of five remaining comparables, which are making losses @ (-) 10.79 % (Autolite India Ltd) and (-) 34.36 % (JMA Industries Ltd) are rejected and only profit making companies are picked up for comparison, it would be seen that average profit of the balance three companies works out to be 4.01 % as against 6.5 % being earned by the assessee. Therefore, on all parameters the transactions of the 19 ITA Nos.4715 & 6086/Del/2010 assessee with its AE can only be concluded to have been held by adhering to principles of arms' length.
(ix) On being asked as to why two loss bearing entities have been selected, it has been submitted that, even if two9 companies given in the list of five remaining comparables, which are making losses @(-) 10.79 % (Autolite India Ltd) and (-) 34.36 % (JMA Industries Ltd.) are rejected and only profit making companies are picked up for comparison, it is observed that average profit of the balance three companies works out to be 4.01 % as against 6.5 % being earned by the assessee. Therefore, on all parameters the transactions of the assessee with its AE can only be concluded to have been held by adhering to principles of arms' length.
(x) It has further been submitted that for the payment of royalty to the AE, an internal CUP is also applicable. These submissions have been made based on the fact that it was only during this assessment year that M/S Stanley Electric Co. Corporation, Japan has become its AE, because it acquired 19.41 % in the paid up capital and has also appointed Executive Director of the assessee has entered into a commercial relationship with Stanley much before it become its AE in assessment year 2004-05. It has also been submitted and clarified that the assessee was paying royalty @ 4% to the Stanley Electric Co. till assessment year 2003-04, when it was not its AE.
However, after it becomes an AE i.e. from assessment year 2004-05, the royalty has been paid @ 3%. To that extent, it was submitted that so far as the royalty payment is concerned, it satisfies all the ingredients of an internal CUP. The courts are continuously taking a view that if internal CUP is available, then there is no need to follow any other method. To that extent, the payment of royalty to the AE by the assessee during the year under consideration is also justified based on internal CUP. Following judgements are relevant for the proposition.
VVF Ltd vs. DCIT [2010-TII-04-ITAT-MUM-TP] Diamond Die Chem Ltd. Vs. DCIT [2010-TII-20-ITAT-MUM- TP]
(xi) It is further submitted that so far as the internal CUP on royalty is concerned, it is also available from the fact that the appellant had paid royalty to two other concerns 20 ITA Nos.4715 & 6086/Del/2010 which are not related to the assessee, as has been pointed out by the Assessing Officer in his order in para 7.2. The assessee has paid royalty to both these concerns @ 4% of the net sales, whereas the royalty to the associated enterprises i.e. Staley Electric Co. Ltd. Japan has been paid @ #%. Therefore, there is no reason to take different view of the matter and the payment of royalty to the to the AE should have been held to be at arms' length price.
During the appellate proceeding, the assessee submitted a chart showing current year data & PLI of the comparables as under :
PARTICULARS India Autolite Fiem Jagan Phoenix JMA Japan 200403 200409 200403 2004-03 2004-03 2004-
(12) (18) (12) (12) (12) 03(12)
INCOME
Net Sales 54.62 74.33 64.73 7.32 147.99 10.78
Other Income .49 0.53 0.26 0.03 1.64 0.25
Stock 0.05 (0.20) (0.53) (1.01) 0.67 0.11
Adjustment
Total Income 55.16 74.66 64.46 6.34 150.30 11.14
EXPENDITURE
Raw Materials 30.33 46.97 40.82 4.22 71.54 6.38
Power & Fuel 2.67 1.82 - 0.09 3.41 0.44
Cost
Employees 2.60 4.93 1.99 0.23 11.87 3.96
Cost
Other 1.45 6.32 11.19 0.66 17.12 1.34
manufacturing
Expenses
Selling and
Administration
Expenses
Miscellaneous
Expenses
Total Expenses 43.77 73.21 59.11 5.83 115.62 14.40
21 ITA Nos.4715 & 6086/Del/2010
PARTICULA India Japan Autolite Fiem Jagan Phoenix JMA
RS
200403 200409 200403 2004-03 2004-03 2004-03
(12) (18) (12) (12) (12) (12)
Operating 11.39 1.45 5.35 0.51 34.68 (3.26)
Profit
Adjustment (6.93) (9.47) (3.61) (0.37) (15.49 (0.51)
for
Adjusted 4.46 (8.02) 1.74 0.14 19.19 (3.77)
Operating
Profit (A)
Net Sales 54.62 74.33 64.73 7.32 147.99 10.78
(B)
Net 8.17% -10.79% 2.69 % 1.91% 12.97 % -34.97 %
Operating
Profit/(Loss)
margin (%)
(A/B)
PBT 4.73 (8.01) 1.86 0.17 13.34 -5.01
Capital 39.85 40.84 28.58 10.52 110.79 6.86
Employed
Fix Asserts 1.10 0.89 2.38 1.07 0.97 0.37
Ratio
PBT/Sales 8.66 (10.78) 2.87 2.32 9.01 (46.47)
%
It was also submitted that this is not an additional data as the TPO himself has referred to all the data i.e. sales etc. in his order in Page 15 in para second.
(xii) It has further been submitted that so far as the claim of the assessee reject Phoenix Lamps Ltd. is concerned, although the assessee itself selected the Phoenix Lamps Ltd. as one of its comparables, yet it was during the course of these appellate proceedings and also during the course of assessment proceedings before TPO pertaining to assessment year 2006-07, the assessee realized that 22 ITA Nos.4715 & 6086/Del/2010 the said company cannot be compared with the assessee.
To that extent, it was refinement of the TP study conducted by the assessee itself. It has been held in the case of DCIT vs. Quark Systems Pvt. Ltd [2010-TIOL-31- ITAT-CHD-SB] that the assessee be allowed to revise its comparables and data because the Transfer Study is a statistical analysis of results of the assessee and are required to be compared with other comparable entities and the assessee should be allowed to revise its study.
It has been claim and contended by the AR of the assessee that Phoenix Lamps Ltd. was not a comparable entity at all and it has been claimed that in assessment year 2006-07, the TPO himself has based on the submission filed by the appellant before the TPO, rejected Phoenix Lamps Ltd. as one of the comparables. A copy of order passed by the TPO for assessment year 2006-07 has been filed before me in support of this contention. It has also been claimed that Phoenix was not comparable even on FAR analysis and ratio analysis and ratio analysis adopted by the TPO was not the correct basis for selecting Phoenix as the lone comparable.
FINDING
6. I have carefully gone through the order passed by the AO/TPO and also the submissions made by the appellant, both in writing as well as oral arguments advanced during the course of proceedings.
7. I have also examined the search process carried out by the assessee ass contained in its T.P. Study compiled by M/S Ernest & Young. The assessee has selected TNMM as the most appropriate method (NAM) as the net margins are less affected by transactional differences than are prices of the products. The search criteria based on functions performed, assets employed and risks assumed based on two data base, i.e. Prowess and Capitalline was deployed, the comparables which were initially selected on a broad basis were narrowed down by referring to the brief description of business, activities undertaken based on financial statements and annual reports in which finally six comparables were selected. Comparables which did not match assessee's production description, which did not have financial data, with no operations etc. were rejected in the T.P. Report.
23 ITA Nos.4715 & 6086/Del/20108. I have examined the details of search process for the comparables and find that the assessee has deployed all necessary filters based on functional tests of the comparables. All other relevant care has also been taken to select the comparables for the purposes of carrying out a detailed FAR analysis. I further note that the T.P. Study has taken into cognizance the overall scenario of auto ancillary industry and other various aspcts in relation to the tested party. Types of functions performed, risks assumed and assets employed have been considered. I therefore, am of the considered view that the assessee's most appropriate method, i.e. TNMM was the proper method to judge the arm's length transactions. Similarly, the comparables selected by the assess based on FAR analysis and a thorough search process were acceptable and the TPO was not justified to reject the comparables without getting into details FAR analysis merely on turnover criteria. I am in agreement with the A.R. of the assessee that high turnover may lead to certain economies of scale. Therefore, I would also like to reject two comparables which are into losses as according to me in these two cases low turnover has resulted into losses and the tested party's turnover has given it the advantage of economies of scale. Therefore, I proceed to examine the assessee's performance under TNMM method by retaining the other three comparables because I further find that the assessee's contentions regarding Phoenix Lamps Ltd has also to be accepted as would be seen from my subsequent findings and reasons.
9. Similarly, the observation of the TPO that the agreement for payment of royalty between the assessee and its AE, Stanley, Japan is merely an agreement without anything more, cannot be accepted in view of the fact that the appellant has been a relationship with the said foreign collaborator before it became its AE and since 1984 and only in assessment year 2004-05 the relationship of AE has been established by the appellant with Stanley Electric Co. of Japan, though the appellant has been paying such royalty for last many year. The royalty is being paid by the appellant from 1984 onwards. During the year under consideration and after becoming the , the rate of royalty has rather been reduced from 4 % 3 %. The appellant is also paying royhalty to other two 24 ITA Nos.4715 & 6086/Del/2010 concerns viz, Robert Bosch, gmbh, Germany and Value Vision, France @ 4 % of its sales, as also observed by the AO in his order in para 7.2.
10. Keeping in view the facts as also the legal submissions made by the appellant, I am of the considered view that AO/TPO was not justified in disallowing the amount of royalty paid by the assessee to its AE. The appellant had been paying royalty at higher rate than paid during the year under consideration to the same entity i.e. Staley Electric Co. Ltd. Japan in assessment year 2003-04. The assessee has also paid royalty to other non AEs @ 4% whereas the royalty to the AE has been paid@ 3 % during the year under consideration. The agreement had been entered into by the appellant in 1984, which is continuing after seeking necessary approval from the Reserve Bank of India on year to year basis. The existence of such agreement cannot be disregarded, especially in view of the judgement of Sony India Ltd. 114 ITD 448 (Del-ITAT). Even the Rule 10B (2) (c) of the Income-tax rules give recognition to this proposition the comparability of international transactions with an uncontrolled transaction shall be judged with reference to the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions.The Indian Income-tax Act and the Transfer Pricing Regulations being a code by itself, extraneous judgements of other countries have no binding precedence value as held by the Hon'ble Supreme Court in Azadi Bachao Andolan case. 263 (ITR 706 (SC).
Therefore the approach of the TPO to treat the agreement as a mere formal agreement based on certain judgements of the foreign courts, has n relevance under the Indian Income-tax Law. The approach of the TPO is lop-sided and is rejected.
11. The other reason given by the TPO to disregard the royalty was that the full-time expatriate qualified engineers have been on the payrolls of the appellant and therefore there was no requirement of payment of any royalty. The answer to this question needs tom be found whether any associated enterprise would give qualified 25 ITA Nos.4715 & 6086/Del/2010 expatriate engineers without any remuneration to the other entity. To my mind, it was only because the appellant was into commercial relationship with the foreign collaborator, that expatriate engineers had been sent to the assessee so that the technology being supplied by the AE of the assessee is properly applied in the production of licensed products. It is not the case of the TPO that the AE of the assessee is not charging a mark-up/cost plus the expats salaries. Rather, such salary is being paid by the AE and assessee is meeting certain expenses on meeting the day-to-day living of such employees. Hence, the factum of putting expats on assessee's premises goes in favour of paying royalty than treating it otherwise.
12. Yet another reasoning of the TPO that only one to two visits have been made to Japan is also factually incorrect, because the engineer/directors of the assessee have visited places like Thailand also. The assessee had filed complete details of foreign travelling in connection with this ground as well as ground no. 4 from where I find that employees of the assessee have visited Japan and Thailand as many as 10 times. Hence, the inference drawn by the TPO is factually incorrect. In fact, these visits coupled with the fact that expats are put by AE on assessee's production base go to prove that assessee was actually getting technical assistance from AE to whom royalty has been paid.
13. The TPO has taken another note of the fact to disallow the royalty payment that the appellant purchased moulds, design and drawings from the associated enterprises. The TPO has drawn his inference based on these items being imported that most of the items are bulbs, sockets, lenses, which do not require any further processing, are likely to be rejected as mere conjectures and surmises because merely obtaining of moulds, designs and drawings have no meaning unless the appellant also knows how to use these drawings, designs and moulds. It is noteworthy to mention that the TPO has not alleged and has also held that international transactions for purchase of these items require no adjustment to the value of its imports. This, to my mind would mean that proper technology and manufacturing process was 26 ITA Nos.4715 & 6086/Del/2010 required to make use of these moulds, designs and drawings for which the payment of royalty was definitely required.
14. Yet another reason given by the TPO in his order is that the appellant did not prove whether any technology was actually received or was required to be received from the AE. These findings of the TPO are merely conjectures and surmises and are contrary to the TPO's own finding, wherein he has accepted the purchase of moulds, drawings, designs from the associated enterprises, for which I hold technology was required and actually obtained as seen from other facts.
15. The TPO and the assessee both benchmarked royalty and raw material on overall TNMM method also and the assessee has also supported the ALP by internal CUP for royalty. I have already held that the method selected by the assessee on TNMM is the most appropriate method for benchmarking the international transactions with the AE of the assessee. I have also held that the comparables found out by the assessee after a thorough search are also broadly acceptable on functional basis.
16. It is, therefore, to be examined whether the adjustment made in the arms' length price on account of purchase of raw material from the AE, which the appellant had justified on the overall TNMM basis is justified or not. The appellant has successfully made out his case for rejection of Phoenix Lamps Ltd. as one of the comparables because the said entity was situated in SEZ and was enjoying certain benefits and was in an advantageous position as compared to the assessee. I fully concur with the view of the appellant that if Phoenix Lamps Ltd. was to be retained as comparable, certain adjustments are required to be made in the said comparable. It is also observed that based on the submissions of the appellant in assessment year 2006-07, the TPO himself has rejected Phoenix Lamps Ltd. as a comparable entity.
27 ITA Nos.4715 & 6086/Del/201017. In assessment year 2006-07, the TPO has retained three comparables under an overall TNMM method, viz. Fiem Industries Ltd., Hella India and India Japan Lighting. It is seen that out of 3 comparables in assessment year 2006-7, 2 comparables exist i.e. Fiem Industries Ltd. and India Japan Lightings in the assessment year under consideration also. Apart from these 2 comparables, 3 comparables have been found by the appellant during the year under consideration i.e. Jagan Lamps Ltd., JMA Industries Ltd. and Autolite India Ltd.
FINDING
18. I find that JMA Industries and Autolite India Ltd. are having huge negative PLI, therefore, I am not inclined to retain the same as comparables because these are huge losses making entities and may require some sort adjustments as per TP Rules. This leaves me with 3 comparable companies i.e. India Japan Lighting. Fiem Industries Ltd. and Jagan Lamp Ltd. whose PLI on a single year basis is as under :-
Comparabales F.Y. 2003-
2003-04
India Japan Lightings : 8.17 %
Fiem Industries Ltd. : 2.69 %
Jagan Lamps Ltd. : 1.91 %
12.77
Average 4.26
This PLI when compared with the PLI of the appellant as has been accepted by the TPO also in his order is 6.50% which is found to be arm's length and therefore, the addition made by the TPO cannot be sustained and the same is hereby deleted. This PLI comparison of the assessee reveals that international transactions on account of royalty as well as purchase of raw material gets benchmarked on an overall TNMM basis also and no addition could be made by the TPO on these two international transactions of royalty and raw material. This is over and above my other findings elsewhere in this order that payment of royalty is justified on internal CUP as well. Hence appellant gets a total relieve of Rs. 2.51,88,406/- on account of these two additions made by the AO/TPO on account of arms length adjustment in international transactions with the AE.
28 ITA Nos.4715 & 6086/Del/201016. It is, thus, seen that by way of international transactions with its AE, the assessee had imported raw material, spares and components, of ` 6,44,50,527/-, purchased moulds/machinery of ` 62,50,907/-, purchased design and drawings of ` 33,18,000/- and had made payment of royalty of ` 2,03,02,776/-, total amounting to ` 9,43,22,210/-. Of these transactions, no adjustment was made by the TPO with regard to the purchase of moulds/machinery and design and drawings. The TPO made adjustment of ` 48,85,630/- in the import of raw materials, spares and components and of ` 2,03,02,776/- (entire amount proposed to be adjusted) qua the payment of royalty. The total adjustment made by the TPO thus amounted to ` 2,51,88,406/-. Though the entire amount of royalty payment, of ` 2,03,02,776/- was proposed by the TPO to be adjusted, in the final adjustment, the ALP was determined by him on an overall basis under the TNMM.
16.1 Vide order dated 15.12.2006, passed u/s 92CA (3) of the Act, the TPO, qua the issue of payment of royalty and import of raw materials, spares and components, observed, as his first finding that in the TP report of the assessee, it had been mentioned that TNMM had been selected as the most appropriate method for determining the ALP; that however, in para 5.3 of the TP Report, concerning the payment of royalty, it had been mentioned that since 1990, the royalty was being paid to Stanley @ 3% of sales and the CUP method could be considered as the most appropriate method, the agreement of royalty having been made under uncontrolled conditions, as during the period from 1990 to 1994, the parties were unrelated; that however, since the agreement was renewable and renewed every year, the agreement entered into in the years 1990-1994 could not be considered as a comparable uncontrolled transaction; that formal agreements between associate enterprises could not be a basis for determining the ALP of 29 ITA Nos.4715 & 6086/Del/2010 the transactions; and that the agreement for payment of royalty was merely a paper document.
17. With regard to this observation of the TPO, it is seen that there are two limbs of this observation; that the agreement concerning royalty is a mere paper document and that even otherwise, the formal agreement between associate enterprises cannot be a basis to determine the arm's length price of the transaction. Now, so far as regards the first limb, i.e., the agreement, according to the TPO, it is a mere paper document, undisputedly, the assessee company is a public limited company, a listed company incorporated under the Companies Act. For years, it has been engaged in the business of manufacture and trade of lighting products for the automotive industry. The assessee company set up its business way back in 1945. At that time, it was a partnership firm. Its business expanded in 1957 and in 1981, it got converted into a private limited company, i.e., Lumax Industries Pvt. Ltd. In 1984, the assessee company went public. It got listed at both NSE and BSE and it was converted into a public limited company. In that very year, i.e., 1984, the assessee company entered into a technical collaboration agreement with Stanley Electric Company of Japan, undisputedly a global market leader in the same industry as that of the assessee company. From the very beginning of the collaboration, royalty was being paid. Initially, it was paid @ 4% on the sale of some of the products produced under the brand name of Stanley. This was later reduced to 3%. In 1994, Stanley acquired some equity stake in the assessee company and in Assessment Year 2004-05, this stake rose to 19.41% of the total paid up capital of the assessee company. In that year, Stanley became an AE of the assessee company. These facts go a long way to establish that in fact, the agreement between the assessee and Stanley is not merely a paper agreement, having subsisted for over 20 years, though renewed 30 ITA Nos.4715 & 6086/Del/2010 every year. The factum of payment of royalty nowhere stands disputed. The relationship of 20 years between the two entities, or two decades, by any standard, is a time-tested partnership or collaboration in a continuous state of stable equilibrium. Further, the fact of the dip in the percentage of payment of royalty from 4% to 3%, which also is undisputed, shows the growth between the two concerns, to a relationship of equity and parity inter se. It goes without saying that the factum of grant of approval by the Reserve Bank of India and other Government bodies like SIA on an year to year basis, which is as per the policy of the Government of India, further strengthens the validity of the agreement. Further, whereas for the year under consideration, the rate of royalty stood reduced from 4% to 3%, the assessee company was also paying royalty to two other concerns, namely, Rober Bosch Gmbh, Germany and Value Vision, France, @ 4% of its sales, which fact has also been taken note of by the Assessing Officer in the assessment order, in para 7.2 thereof.
18. In 'Sony India (P) Ltd. vs. DCIT', 114 ITD 448 (Del), the agreement being dealt with was an agreement similar to that under consideration herein. The Hon'ble High Court held, inter alia, that the income-tax authorities have no power to rewrite a transaction and the actual transaction as entered into, is to be considered; that this is the legal position under the fiscal laws and an exception may be taken only where the transaction is a sham or bogus transaction or a transaction entered into by the parties in bad faith to avoid and evade taxes. As in that case, herein also, there is no allegation whatsoever by either the TPO or the Assessing Officer, that the transaction concerning payment of royalty had been entered into for any purpose other than the one professed and reflected by the parties. That being so, there was no occasion for the TPO to hold the agreement in question to be a mere paper agreement.
31 ITA Nos.4715 & 6086/Del/201019. Likewise, in 'Abhishek Auto Industries vs. DCIT', 136 TTJ 530 (Del), it has been held that legally binding agreements between unrelated parties cannot be disregarded without assigning any cogent reason therefor. Therein also, like in the present case, there was no allegation by the taxing authorities that the agreements were ingenuine or sham. Rather, those agreements also, like the one involved herein, had been accorded due approval by the RBI and other regulatory agencies. It was reiterated to be a settled legal position that commercial transactions are in the domain of the businessman and the income-tax department cannot intervene in the realm of intricacies of commercial expediencies involved in the concerned arrangements.
20. Thus, there was no reason for the agreement herein to be doubted as a mere paper agreement, particularly when in numerous earlier years, this very agreement stood approved and accepted by the department itself.
21. So far as concerning the other observation, regarding the agreement, if taken to be a valid agreement, being of no consequence, this observation is of the type of a 'without prejudice' observation of the TPO. Once the validity of the agreement per se has been accepted year in and year out, it does not lie in the mouth of the TPO/Assessing Officer to say that it is baseless. Rather, it goes without saying that the very payment of the royalty finds its basis in the agreement, which fact has nowhere been doubted by TPO/Assessing Officer.
22. Rule 10B(2)(c) of the IT Rules reads as follows:-
" 10B (2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:--32 ITA Nos.4715 & 6086/Del/2010
(a) ..............;
(b) ...............;
(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;"
23. It is evidently clear from Rule 10B (2)(c), that it is the contractual terms of the transactions involved, which govern the action of judging the comparability of an international transaction with an uncontrolled transaction. That the Rule is mandatory is amply clear from the use of the expression 'shall' in the opening part of Rule 10B (2).
24. All these factors have duly been taken into consideration by the Ld. CIT (A). The findings of the Ld. CIT (A) in this regard are elaborate, self contained and speaking. Therefore, we find the order of the Ld. CIT (A) with regard to this aspect of the issue of addition of ` 2,51,88,406/-, to be on all fours.
25. The next objection raised by the TPO was that since Stanley had provided full time expatriate employees/qualified engineers to the assessee company, there was no need for the assessee company to receive any further technology, the said technical personnel having been in full time employment of the assessee and the know-how having been provided by he said technical personnel. Here, it is seen that the assessee has maintained, and the same has remained undisputed, that the technical personnel employed were expert qualified engineers provided by Stanley to the assessee company. It was their presence which resulted in the high quality of the products manufactured by the assessee. This high quality could be achieved through various technical discussions with engineers and the vendors of the assessee, who were both Indians as well as foreigners. Such arrangement of obtaining engineers obviously could have come about 33 ITA Nos.4715 & 6086/Del/2010 only on payment and such payment was by way of royalty. The expatriate personnel, i.e., expert qualified engineers, were deputed by the assessee's AE on the rolls of the assessee company and it was thereby, that the technology was provided to the assessee company. As such, it was only because of the commercial relationship of providing technology, for which the royalty was paid and such payment was, undoubtedly justified. In this regard, as correctly found by the Ld. CIT (A), no associated enterprise would make available qualified expatriate engineers, without remuneration. By virtue of sending the expatriate engineers to the assessee, it was ensured that the technology being supplied by Stanley to the assessee was properly applied to the production of licensed products. As correctly noted by the Ld. CIT (A), it was the AE, who paid the salary to the expatriate employees and the assessee made the expenses concerning their day- to-day living. The TPO had not raised any doubt that Stanley was not charging a mark up/cost plus on the salaries of the expatriate employees.
26. In this regard, in 'Abhishek Auto Industries' (supra), it has been taken note that whenever international transactions of such a nature are undertaken, it is a combination of technical know-how, royalty and technical assistance through the deputation of expatriate employees on the rolls of the person obtaining the technical know-how and that merely by importing machinery, it cannot be said that the assessee would become competent to make use of such machinery.
27. Accordingly, here too, the observation made by the TPO casts no serious detriment to the case of the assessee and the Ld. CIT (A) has correctly repelled such observation. It merits adding here that there is no case made out by the taxing Authorities that the technology sought to be, and in fact, acquired by the assessee was a screw driver or 34 ITA Nos.4715 & 6086/Del/2010 ready to use technology requiring no further training for putting the same to use.
28. The next observation made by the TPO against the assessee was that the claim of the assessee that Lumax engineers and directors visited the manufacturing unit of Stanley to get the training of the latest know-how, was false. The TPO observed that in this regard, as per the details filed, 34 foreign visits were undertaken by various employees and directors of the assessee company; that however, barring one or two visits to Japan, all other visits were made to different destinations like Thailand, the UK, Europe, Korea, the USA, Dubai, Malaysia, Singapore, Bangkok, Australia, etc.; that therefore, the assessee's contention that its engineers had visited its AE's or Stanley's units for getting trained in the technology was a blatant lie and the assessee had resorted to suppressio vari and suggestio falsi. Here, it is seen that as correctly maintained on behalf of the assessee, not only Stanley, Japan, but also its 100% subsidiaries also fall in the category of 'associate enterprise' of the assessee, as defined in Section 92A(2) of the Act. Now, it remains an unchallenged fact that the visits made by the employees of the assessee company were to the factories of those companies, which were also the AEs of Stanley, Japan. As per the record, ten visits were made to Japan and Thailand, where the AEs of the assessee were situated. The purpose of these visits was only to get the requisite training to enable application of the technology made available by the AE only. Obviously, it would not at all be commercially expedient to incur such foreign traveling expenses without business necessity, nor is this the case of the TPO himself. The Ld. CIT (A) has taken due note of the fact that international transactions of import of raw material, spares, etc., had taken place with Thailand also, where the AEs of the assessee existed and where the engineers/directors of the assessee company had visited. The 35 ITA Nos.4715 & 6086/Del/2010 details of the foreign traveling were found by the CIT (A) to be in order. This has not been challenged. Further, it has also come as an unrebutted finding of fact from the Ld. CIT (A), that pursuant to the visits abroad, the expatriate employees were put on the assessee's production base by the assessee's AE, going to prove that the assessee company was actually getting technical assistance from Stanley. Therefore, the payment of royalty was correctly held to be justified on this count also.
29. The next objection raised by the TPO was that the assessee had purchased moulds and designs and drawings from its associate enterprises; that such purchases of moulds and drawings were of around ` 1 crore; that since the assessee had purchased separately, the moulds as well as designs and drawings, payment of royalty in addition thereto could not be justified; that the moulds were not new products; that the details of the raw material purchased showed that most of the items were bulbs, sockets, lenses, etc.; that since the assessee was manufacturing only head lamps and tail lamps for automobiles, i.e., two-wheelers and four-wheelers, the materials purchased were not items of processing and so, it was not comprehensible as to what further technology might be required for manufacturing lamp items, when moulds had been purchased along with various components.
30. In this regard, as rightly contended, it is seen that mere import of drawings, designs and moulds does not per se lead to an assumption that the assessee had, thereby, acquired the know-how to make the designs and, ultimately, the product. The user, i.e., the assessee in this regard must know how to use the drawings, designs and moulds. As correctly taken note of by the Ld. CIT (A), it is nowhere the TPO's case that for the purchase of these items, the international transactions do not require any adjustment to the value of the imports. From this, it is 36 ITA Nos.4715 & 6086/Del/2010 evident that proper technology and knowledge of the manufacturing process was required so as to utilize the moulds, designs and drawings and it was for this, that the payment of royalty had to be made. In 'Abhishek Auto Industries' (supra), on this aspect, it has been held that where the TPO had accepted the international transactions of purchase of machinery by the assessee from its AE, but an inference had been drawn that the assessee was competent to make independent use of such machinery, whenever international transactions of such a nature are undertaken, it is a combination of technical know-how, royalty and technical assistance through the deputation of expatriate employees on the rolls of the person obtaining the technical know-how and it cannot be said that merely by importing the machinery, the assessee would become competent to make use of such machinery. Thus, the observation of the TPO in this regard too does not hold much water and the same has been rightly rejected by the Ld. CIT (A).
31. The TPO has also observed that since according to him, the reason for making payment of royalty by the assessee to its AE was not receipt of any technology, but a formal agreement only and since the assessee had failed to substantiate that any technology was actually received or even was required to be received by it from its AE, the payment of royalty could not be said to be justified.
32. Here, as noted above, the agreement between the assessee and its AE is not a mere formal agreement, but a long standing contract, which has withstood the test of time and which has been accepted by the department itself, year after year. Thus, the history of the assessee's case is the accepted history, finding its base in the very agreement which the TPO, merely on conjecture and surmise, had tried to dub as a mere paper agreement. In fact, the agreement, renewed from year to year, has been analysed in detail by the Tribunal, as also by the Hon'ble Delhi High Court in the assessee's own case. And not 37 ITA Nos.4715 & 6086/Del/2010 only this, as also observed by the Ld. CIT (A), such findings of the TPO are intrinsically mutually contradictory with his own findings in the very same order, whereby the purchase of moulds, drawings and designs by the assessee from its associate enterprise stands accepted. Now, as discussed, it goes without saying that to put these moulds, designs and drawings to use, transfer of technology by the AE to the assessee was required and such technology was received by the assessee. Moreover, the agreement, i.e., the Technical Assistance Agreement between the assessee and Stanley itself is eloquent in this regard and it would be appropriate to reproduce herein, certain relevant extracts thereof, as placed before us:-
"PB Page 14 14 - relevant extracts from the Technical Assistance Agreement WHEREAS LUMAX is already producing Lighting Equipments for Automobiles and now intends to upgrade technology for producing such Lighting Equipments for Automobiles and Motorcycles including Motor Scooters and Mopeds as complying with the aforementioned standards, and for this purpose desires to obtain a right and license to manufacture and sell products defined hereinafter under STANLEY's patents and manufacturing know-how and its technical assistance.
PB page 23 - relevant extracts from the Technical Assistance Agreement LUMAX shall not use the trade name of STANLEY, brand name or its unique design on the Licensed Products or packing boxes thereof. In cases where LUMAX uses CKD parts purchased from STANLEY, where these CKD parts bear the STANLEY trademark and/or name, LUMAX shall be authorities to use these parts. STANLEY shall also permit LUMAX to imprint on Licensed Products or components/cartons thereof, a LOGO during the currency of this Agreement.
PB page 30 - relevant extracts from the renewal of Technical Assistance Agreement WHEREAS Stanley is willing to continue to grant said right and license defined in AGREEMENT and its supplement to Lumax; and 38 ITA Nos.4715 & 6086/Del/2010 WHEREAS Lumax desires to extend the same in order to meet customer's technical and quality requirement and to maintain competitiveness in the market.
PB page 31- 31- relevant extracts from the renewal of Technical Assistance Agreement Rate of Royalty shall continue to be Three Percent (3%) subject to taxes on all new Lighting Equipments manufactured and supplied by Lumax utilizing the technology license and/or technical assistance provided by Stanley."
33. Further, the assessee has also placed before us, at pages 168- 173 of the assessee's paper book, a copy of the assessee's submissions filed with the TPO, on 28.11.2006. Therein (at APB 171-
173), the assessee submitted a detailed note regarding receipt/upgradation of technology during F.Y. 2003-04, the manner of such receipt, and the three orders of models of Japanese OEMs obtained, like Maruti, Honda, etc., for which, technical know-how had been provided on a day-to-day basis. These details cast ample light on the issue of requirement of technology and though these details were placed before the TPO, the TPO made the observation in this regard entirely oblivious to these details. Thus, the observation/finding of the TPO in this regard, besides being based on mere assumptions, conjectures and surmises, is also a result of complete misreading and non-reading of material brought on record by the assessee. We consider it appropriate, as such, to reproduce these details hereunder:-
3. To give details of Receipts of Technology/Upgradation of Technology during the F.Y. 03-
03-04. Also to give exact exact Form and manner of Receipt with supporting documents.
The brief history of payment of royalty is as under :-
Royalty is being paid by the company under collaboration agreement entered by the company (Lumax) with M/S Stanley Electric Company Limited. Japan (Stanley) dated 10-5-1984 and as approved by the Government of India, Ministry of industries vide their letter dated 28-08-1984 and the said agreement was also duly recorded with Reserve Bank of India. The aforesaid agreement was renewed several times by entering in to 39 ITA Nos.4715 & 6086/Del/2010 supplementary agreements. I am enclosing herewith a certificate of S.R.Batliboi and Associates, Chartered Accountants which contains all the details of the renewal agreements with dates of the approval by the Central Government and date of recording by the Reserve Bank of India. It is to be further submitted that initially the rate of royalty was 4% which was reduced to 3% on 2-02-1990. The Stanley Japan took up the stake in Lumax in 1994 and their stake in the financial year 2003-04 amounts to 19.41% of the total shareholding.
As per the agreement with the Stanley Electric Company they have to provide to the assessee company a non exclusive right and licence to manufacture and sell the licensed products in India under the Stanley's patents and/or technical information besides granting further non-exclusive right to sell the licensed product manufactured in India and in other countries except Japan. Article 3 of the aforesaid agreement provided that the foreign firm was providing to Lumax, technical assistance to the extent mutually agreed namely :-
"1.1 STANLEY will render and communicate or procure to be rendered and communicated to Lumax Technical Information and assistance relating to the Licensed Products from time to tine as agreed by the parties.
1.2 STANLEY will make available to Lumax promptly necessary Technical Information which are from time to time incorporated in STANLEY'S production of any of the Licensed Products to enable Lumax to apply such Technical information to the Licensed Products manufactured by Lumax.
1.3 STANLEY will use its best endeavours to assist LUMAX and provide LUMAX with necessary technical advice in producing the Licensed Products which are satisfactory of the quality, performance of fitness of the Licensed Products manufactured by LUMAX.
1.4 Upon the request of LUMAX and/or when it is considered necessary by STANLEY to do so, STANLEY will make available to LUMAX technical advice on purchase, installation, operation and maintenance of machines, equipment and facilities which are required for the production of the Licensed Products.
1.5 As necessary from time to time, upon the request of LUMAX, STANLEY agrees to dispatch its technical personnel to LUMAX to advise and assist LUMAX in obtaining the best utilization of the Technical Information and to provide additional Know-how regarding the manufacturing of The licensed products.40 ITA Nos.4715 & 6086/Del/2010
1.6 As necessary from time to time, upon the request of LUMAX, STANLEY agrees to accept LUMAX's technical personnel at STANLEY's factory at such times and in such numbers as mutually agreed upon for technical instructions and training.
1.7. LUMAX will develop its own Research and Development facilities in order to absorb the technical know-how from STANLEY during the currency of this agreement and STANLEY will provide such technical assistance and advice as shall be reasonably necessary for the purpose."
From the above your honour will note that the royalty is being paid on account of the following.
Lumax has a right and license to manufacture and sell licensed products in India under Stanley's Patents and/or Technical Information during the tenure of the agreement. Lumax therefore pays royalty for the manufacture and sale of the licensed products. All the products are manufactured by Lumax in-house in its existing production facilities.
Secondly, as contained in Article '3' of the agreement, Stanley provides to Lumax, technical information and assistance relating to the licensed products from time to time by giving necessary advice in production of the licensed products for its production and make available their technical personal to assist in best utilization of the information made available etc. Article 8 of the agreement also provides that the Stanley shall grant a license in respect of acquisition of any patent or invention in future in respect of the licensed products.
As per Article 11 of the agreement Lumax is also authorised to imprint on the license products on components/cartons thereof, a LOGO during the currency of the agreement as under :-
"MED. UNDER LICENSE FROM STANLEY JAPAN"
It is to be submitted that due to the collaboration agreement with the Stanley, Lumax is getting sales orders almost from all the vehicle manufacturers and the turn over of the company has increased from 530 Million in 1993-94 to 2308 Million during the year under reference and increase in sales is due to the collaboration agreement with the Stanley. This is also a fact that multinational companies who have setup their manufacturing units in India deal with the Indian Companies who have very high standard manufacturing facilities with collaboration agreements with renowned MNCS'. Profile of Stanley have already been submitted on page 5 of Transfer Pricing Report.
41 ITA Nos.4715 & 6086/Del/2010During the year Lumax has obtained fresh orders in respect of the following new products for which technical know-how has been provided on day to day basis to the manufacturing units of the Lumax
1. Maruti Udyog Ltd.- High Mount Stop Lamp H/L. T/L of Zen Minor High Mount -Baleno
2. Honda Scooter & - KRBA -Eterno Motorcycles
3. Hero Honda - Passion, Splendor During the year Lumax engineers and directors visited the manufacturing units of Stanley to get training of the latest technical know- how which was under the use at the manufacturing units of the Stanley and detail of visits made be the Lumax engineers is enclosed herewith.
With the suggestions and know- how provided by the Stanley the assembly line has been changed to 'U' 'T' 'V', or 'L' shaped for improving the production and also initiatives have taken to plan and absorb new technology like LED applications.
It is to be further submitted that collaborators has provided Japanese engineers on deputation as full time employees to Lumax and during the year Mr.Y. Muraga & Mr. S.Watanabe were employed with Lumax. Their presence has great impact on the quality of the products manufactured by Lumax and for various technical discussions with engineers of the vendors who are both Indians as well as foreigners.
4. To explain why the comparable have been rejected on the basis of Product differentiation, when exact product similar have not required under TNMM method.
Although the rules permit broader product differences in the application of TNMM, they prefer choosing of the best comparables possible as they would provide a more reliable final result. An extract from the Advance Pricing Agreement Program Training Manual is provided below for your ready reference:
"The basic standard in the regulations is that one should select the most comparable and reliable potential comparables, and only include potential comparables that are not "significantly" less comparable and reliable than the best ones available..... When some comparables are of high enough quality so that the arm's length range 42 ITA Nos.4715 & 6086/Del/2010 would include all of their results..... one normally should use them to the exclusion of others, which normally would be deemed "significantly" less comparable or reliable."
Widening of the comparable set to similar products would lead to inclusion of all auto ancillary electricals and other parts like wiper blades, mirrors and windshields, horns, dashboard plastics, etc. While these products could've been included, they are functionally very different and very different technologies go into the manufacture of the same. For example, the kind of investment required in moulds and machinery required for the manufacture of automotive lighting products would be very different from the investment required for the manufacture of wiper blades, horns, etc. Automotive lighting, though a specialized product industry, has various companies that engage exclusively in the production of the same and hence, a need to widen the acceptability criteria wasn't required. In addition, since we found 4 companies that were exact comparables of LIL in terms of products manufactured, a need for broadening the search criteria wasn't considered necessary.
5. To provide Custom valuation copy.
This is to inform you that during the year there were more than five hundred import consignments and for your ready reference we are enclosing herewith valuation copies of the capital goods and HOOD CP and socket CP (Components) with details. From the same your honour will note that the invoice values were accepted by the custom department. It is to be further stated that in all cases the invoice values have been accepted by the custom department. In case your honour desire to verify documents of any consignment of import, the same shall be produced for your verification."
34. In view of the above, this observation/finding of the TPO is also baseless and it was correctly rejected by the Ld. CIT (A).
35. The fact of the matter, as noted, is that the assessee has been paying royalty to Stanley from 1984 and such payment has been allowed to the assessee by the Assessing Officer himself upto Assessment Year 2003-04, from Assessment Years 1984-85 to 1993- 94, as a 100% revenue expenditure. In Assessment Years 1994-95 to 43 ITA Nos.4715 & 6086/Del/2010 1999-2000, though the Assessing Officer had allowed the royalty as a bona fide payment, 25% thereof had been capitalized. The matter was carried up to the Hon'ble High Court and the Hon'ble High Court, vide its judgement reported in 173 Taxman 390 (Del), on examining the clauses of the agreement between the assessee and Stanley, held that the royalty was required to be paid by the assessee to Stanley for its bona fide business need and that the same represented revenue expenditure. Undisputedly, all through, the royalty agreement, right from Assessment Year 1984-85, till the year under consideration, has remained essentially the same agreement, in spirit, substance and intent. In Assessment Year 2003-04, the equity stake of Stanley in that of assessee company amounted to 19.41%. Stanley also appointed an Executive Director on the Board of the assessee company. By virtue thereof, Stanley became an AE of the assessee company within the meaning of Section 92A (2) (e) of the Act. In view of this history of payment of royalty, spanning 20 years or two decades, obviously, neither the genuineness of the transaction, nor the business expediency forming the basis of the payment of royalty, attracts even an iota of doubt. The TPO has nowhere made out a case that profit was shifted from a higher tax jurisdiction to a lower tax jurisdiction. In fact, there was no, as there could have been no, motive for any such shifting of profits at the hands of the assessee company and there could have been no reason for a majority stakeholder in India (the assessee) to over pay even a single paisa to the minority stakeholder in Japan (Stanley). The TPO fell in error in ignoring the position that it is if and only if it stands proved that there was manipulation of prices to avoid taxes in India, that the transfer pricing provisions of the Act can be invoked. Now, obviously, once the shareholding of Stanley was only to the extent of 19.51%, the assessee company would not have avoided taxes by shifting profits to Stanley. That transfer pricing regulations in India have been brought on the statute book with the 44 ITA Nos.4715 & 6086/Del/2010 intent of preserving tax base in India and preventing tax evasion through manipulation of pricing of inter company transactions, is also evident from CBDT Circular No.14/2001, providing the Explanatory Notes on provisions relating to direct taxes with respect to Finance Act, 2001. As per this Circular (also brought to the notice of the Assessing Officer by the assessee by way of its submissions dated 20.12.2006, copy at APB 189-218, relevant portion at page 194, para 3.1):-
"The profits derived by such enterprises carrying on business in India can be controlled by the multinational group, by manipulating the prices charged and paid in such intra-group transactions, thereby leading to erosion of tax revenues. ........ The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country's tax base."
36. It is noteworthy that during the period Assessment Years 1990- 94, the AE of the assessee did not hold any equity share in the assessee company and so, by transferring income through payment of royalty or purchasing raw material or capital equipment from Stanley, the assessee would earn no benefit. However, even at that time, royalty @ 3% of the sales was being regularly paid by the assessee to Stanley, proving the veracity of the contract between the assessee and Stanley, made under uncontrolled conditions and renewed every year, at the same rate, or at arm's length. Intention of tax evasion could have been imputed to the assessee company in case the payment of royalty had commenced only after the relationship of associate enterprise had been established, or when, if at all, the rate of payment of royalty had undergone an increase. However, neither of these has been shown by the TPO/Assessing Officer to be an existing circumstance here.
37. It is also seen that it remained to be taken cognizance of by the TPO/Assessing Officer, that the payment of royalty was being made by 45 ITA Nos.4715 & 6086/Del/2010 the assessee only on the products being produced under licence from Stanley and no royalty was paid on items manufactured and sold under the assessee's own brand. This is evident from the fact that the sales (APB 101) were of ` 230 crores and the royalty paid amounted to only ` 2.03 crores, equivalent to less than 1% of the sales. This goes to show that as contended, only about 1/3 of the sales of the material produced under licence from Stanley, which material was sold by the assessee company to Japanese OEMs, was subject to royalty payment. Further, application of tax avoidance provisions could have been justified, if the rate of tax was lower in Japan, as compared to that in India. However, the fact of the matter is that whereas the relevant tax rate in India is 30.90%, the corresponding rate in Japan is 40.69%. That being so, it is beyond comprehension as to why the assessee would harbour any motive of shifting income, as tried to be made out. Indeed, payment of royalty by the assessee (an Indian company) to Stanley (a Japanese company) involves no tax avoidance and none has been shown to exist.
38. Further still, the assessee company is under the control of its Indian management and promoters. A majority of its directors are independent and include nominees of Government bodies. It is a listed company. Stanley is neither a majority shareholder of the assessee company, nor does it have a majority on the Board of Directors of the assessee company. In such a tight scenario, a seamless transfer is just not possible between the assessee company and Stanley. It has not been suggested, much less shown otherwise.
39. Too, considering as to how the royalty is accounted for by Stanley in its financial statements/documents as an income, it is being subjected to tax as per the Japanese law. A copy of Stanley's annual report is contained at pages 386-420 of the assessee's paper book for Assessment Year 2008-09. As available at page 403 of the said paper 46 ITA Nos.4715 & 6086/Del/2010 book, as per the income statement of Stanley, receipt of royalty of about 10 million US $ has been shown for the years ended 31.03.07 and 31.03.08. This is equivalent to about ` 50 crores. Stanley is shown to have made income-tax provisions of about 138 million US $ in each of these two years. So much for the doubt entertained by the TPO/Assessing Officer regarding tax avoidance at the hands of the parties to the payment of royalty.
40. Coming to the method applied by the assessee to justify the payment of royalty, in its Transfer Pricing Study, the assessee justified payment of royalty on the basis of the internal CUP method. Royalty had been paid, to reiterate, by the assessee company to Stanley @ 4% in the years when there did not exist any relationship of AE within the meaning of Section 92A of the Act between the two entities. Subsequently, on the coming into existence of the relationship of AE in Assessment Year 2004-05, i.e., one of the years under consideration, on the sales made using the licensed technology, @ 3%. This has been duly taken note of by the Ld. CIT (A), in para 9 of the impugned order. The Ld. CIT (A) also noted that besides, the assessee was paying royalty to two other concerns, namely, Rober Bosch Gmbh, Germany and Value Vision, France, @ 4% of the sales. The Assessing Officer had also noted this fact. Thus, whereas the payment of royalty to Rober Bosch and Value Vision during the year was @ 4%, it was @ 3% to Stanley. Indeed, in such a circumstance, application of the internal CUP method, when internal comparison was available, is wholly justified, in keeping with the following decisions:-
i) 'Abhishek Auto Industries', 136 TTJ 530 (Del)
ii) 'Birla Software India vs. DCIT', 136 TTJ 505 (Del)
iii) 'VVF Ltd. vs. DCIT', 2010-TII-04-ITAT-Mum-TP and
iv) 'Diamond Di Chem Ltd. vs. DCIT', 2010-TII-20-ITAT- Mum-TP.47 ITA Nos.4715 & 6086/Del/2010
v) 'Serdia Pharmaceuticals India Pvt. Ltd. vs. ACIT', 2011-TII-02-
ITAT-Mum-TP.
40.1 'Abhishek Auto Industries' (supra) holds that the best comparability can be of the transactions of the tested party itself. As per 'Serdia Pharmaceuticals India Pvt. Ltd.' (supra), the CUP method is to be preferred, as long as it can be reasonably applied in determining the arm's length price of an international transaction in a particular fact situation and unless another method is proving to be more reliable a method vis-a-vis the fact situation of that particular case, since when associate enterprises entering into a transaction by such conditions in commercial and financial terms, which are different from the commercial and financial terms imposed in comparable transactions between independent enterprises, the differences in two sets of conditions in financial and commercial terms are attributed to interrelationship between the associate enterprises that is sought to be neutralized by the transfer pricing regulations.
41. Then, as noted hereinabove (para 22), Rule 10B(2)(c) of the Rules states as under:-
"10B(2) For the purposes of sub-rule (1), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely,
(a) .......
(b) .......
(c) The contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions."
42. So, the arm's length price of an international transaction shall be determined, as per the Rule, on the basis of and with reference to the contractual terms of the transactions. The TPO and the Assessing 48 ITA Nos.4715 & 6086/Del/2010 Officer erred in ignoring the applicability of Rule 10B (2) (c) of the Rules and the Ld. CIT (A) rightly rejected this approach.
43. The TPO applied the TNMM and recommended upward adjustment of ` 2,03,02,776/-. The assessee had benchmarked the royalty and raw material on overall TNMM, besides supporting the ALP for royalty by the internal CUP, as above. The CIT (A) held that TNMM was the most appropriate method for benchmarking the international transactions with the assessee's AE and that the comparables found out by the assessee were also broadly acceptable on a functional basis. This has not been shown to be incorrect. Firstly, the TPO had erred in applying the TNMM as against the internal CUP, particularly in view of 'Serdia Pharmaceuticals' (supra), as discussed hereinabove. Then, it was, chiefly, the information supplied by the assessee itself, that the TPO proceeded on. However, the assessee had itself selected TNMM as the most appropriate method also. This is so, since, as noted by the Ld. CIT (A), the net margins were less affected than the prices of the products by transactional differences. The FAR analysis by the assessee was based on two data bases, i.e., Provess and Capital-line. Making reference to the brief description of business and activities undertaken, based on financial statements and annual reports, the comparables were narrowed down and six comparables were finally selected in the assessee's TP Report. The Ld. CIT (A) found all necessary filters based on functional tests of the comparables to have been deployed by the assessee. All other relevant care was also found to have been taken by the assessee to select the comparables for the purposes of carrying out a detailed FAR analysis. The TP Study was observed to have taken into cognizance the overall scenario of the auto ancillary industry and other various aspects in relation to the tested party. It was in view of these observations, as made by the Ld. CIT (A) in paras 7 and 8 of the impugned order, that the CIT (A) held 49 ITA Nos.4715 & 6086/Del/2010 that TNMM was the most appropriate method in the assessee's case. It has not been shown as to how this is incorrect. The CIT (A) observed that the TPO was not justified in rejecting the comparables without going into detailed FAR analysis, merely on the turnover criterion. As to how the approach of the TPO could be said to be as per law, has not been demonstrated. Of the six comparables given by the assessee, the TPO rejected all, other than Phoenix Lamps, even though all the comparables were selected by the assessee as per a scientific research process, analyzing the business description and the items manufactured by the comparable companies. The TPO determined a shortfall of ` 11.94 crore in the profitability of the assessee, while comparing the results of the assessee with Phoenix Lamps Ltd. This shortfall was brought down to ` 9.91 crore by reducing the royalty to `2.03 crore. The assessee's purchases from its AE, of ` 6.44 crore represented 4.93% of the total purchases of ` 130.47 crore. On this, the TPO worked out an arm's length adjustment in purchases amounting to ` 48,85,630/-.
44. The CIT (A), however, rejected two comparables which were into losses, i.e., Auto Light India Ltd. and JMA Industries, since, according to her, in those two cases, it was low turnover which had resulted into losses and the turnover of the tested party had given it the advantage of economies of scale. Apropos Phoenix Lamps, the CIT (A) observed that it was situated in an SEZ and it was enjoying certain benefits and was, thus, in more advantageous position as compared to the assessee. She held that if Phoenix were to be retained as a comparable, certain adjustments were required to be made to its statistics. Therefore, observing that based on the assessee's submissions in Assessment Year 2006-07, the TPO had himself rejected Phoenix Lamps, the CIT (A) also proceeded to reject Phoenix Lamps Ltd. as an entity comparable to the assessee company. The remaining 50 ITA Nos.4715 & 6086/Del/2010 three comparables, i.e., Indo-Japan Lightings, Fiem Industries Ltd. and Jagan Lamps Ltd. were retained by the CIT (A). The PLI's of these comparables were 8.1%, 2.69% and 1.91% respectively, amounting to a total of 12.77%. The Ld. CIT (A) worked out the average PLI of these comparables at 4.26%. The assessee's margin, at 6.5%, it is seen, is higher than the above average PLI of 4.26% and the assessee's margin, therefore, does not call for any adjustment on account of ALP concerning royalty payment on purchase of raw material. The CIT (A)'s order in this regard is found to be fully justified as against that of the TPO, who initially observed that an FAR convergence was mandatory and then, simply rejected the comparables on the basis of turnover, without checking out the FAR convergence, and thereafter, chose a single comparable which too (according to him) was not comparable to the assessee company, which observation has correctly been subverted by the Ld. CIT (A). Then, the action of the TPO in not conducting any FAR analysis for the company accepted by him and not making any adjustment in the profits of the single comparable retained by him, as rightly contended, is against Rule 10B(3) of the Rules, as per which Rule [Rule 10B(3)(ii)], an uncontrolled transaction shall be comparable to an international transaction, if reasonably accurate adjustment can be made to eliminate the material facts of difference, if any, existing between the transactions compared, or between the enterprises entering into such transactions. Since Phoenix Lamps, as found by the Ld. CIT (A), was operating in an SEZ, it, in order to be retained as a comparable, would have required adjustments to be made for the purpose, which, undeniably, was not done by the TPO. As such, Phoenix was rightly rejected as a comparable by the CIT (A). Even otherwise, undisputedly, the product manufactured by Phoenix is entirely different from that produced by the assessee. Whereas the assessee manufactures the complete lamp, i.e., the full lighting assembly or headlight/tail-light used in automobiles, Phoenix is making 51 ITA Nos.4715 & 6086/Del/2010 only the bulb contained therein. So, whereas the product of the assessee is the whole, what is manufactured by Phoenix is only a part. Hence, on this preliminary score too, Phoenix nowhere qualifies as a 'comparable' to the assessee.
44.1 In this regard, in 'E-gain Communication Pvt. Ltd.', 2008-TIOL- 282-ITAT-Pune, it has been observed that the revenue should opt for robust and comprehensive FAR analysis for choosing comparable companies and if need be, the necessary adjustments can also be made in the operating profits of the comparable companies. In the present case, on the other hand, as observed, the TPO rejected the comparables selected by the assessee, merely on the basis of the turnover criterion, even though this is nowhere mandated as a criterion in Rule 10B (2) of the Rules.
45. For the above discussion, finding no error whatsoever therein, the Ld. CIT (A)'s order on this issue is hereby upheld and ground No.3 raised by the department is rejected.
46. Coming to Ground no.4, the department alleges that the Ld. CIT (A) has erred in deleting the addition of ` 2,59,434/- on account of foreign tour of the Director of the assessee company. The Assessing Officer observed that the assessee's Director, Shri D.K. Jain had incurred an expenditure of ` 1,11,497/- on his visit to the USA on 15.08.2003 and that of ` 1,47,937/- on his visit to Dubai on 01.10.2003. Holding that these visits had no business connection and were not commercially expedient for admissibility u/s 37(1) of the Act and that the assessee had failed to substantiate the reasonableness and genuineness of the foreign expenses, the Assessing Officer disallowed the amount of ` 2,59,434/- and added it to the income of the assessee. The Ld. CIT (A) deleted this addition, giving rise to the department's grievance by way of the ground at hand.
52 ITA Nos.4715 & 6086/Del/201047. The Ld. DR has contended that the disallowance correctly made has wrongly been deleted by the Ld. CIT (A), ignoring the fact that the foreign tours were not undertaken by the Director of the assessee company for any business purpose, as correctly observed by the Assessing Officer.
48. The ld. counsel for the assessee, on the other hand, has strongly relied on the impugned order in this regard, contending that all the details with regard to the two foreign visits were duly filed along with the details of the transactions undertaken with the two countries visited by the Director of the assessee company, either during the year, or in the subsequent year.
49. The Assessing Officer, it is seen, observed that since there had been no import from the two countries, there was no business connection and the expenditure incurred was not commercially expedient. The Ld. CIT (A) has taken due note of the fact that the assessee had exported goods to the two countries visited by its Director, i.e., the USA and Dubai (UAE). These details are as under:-
Director Name Country Party visited Purpose of the visit visited Mr. D.K. Jain USA M/s JOHN DEERE 300, Export of Rs.20,467/-
North Vine Street, during the F.Y. 2003-04
Horicon, WI 53032, and Rs.73,84,534/- for
USA F.Y. 2005-06 as 2003-04
was a promotional year
for getting more orders
in future years.
Mr. D.K. Jain Dubai M/s Alihthiyati Auto Export of Rs.4,85,268/-
Parts Est. P.O. Box during the F.Y. 2003-04.
22049, Sharjah-UAE.
Mr. D.K. Jain Dubai M/s Al Shirwai Export of Rs.3,85,220/-
Equipment Company, during the F.Y. 2003-04.
LLC. P.O. Box 10983
Dubai-UAE.
Mr. D.K. Jain Dubai M/s Jini Auto Parts, Export of Rs.93,316/-
P.O. BOX 4325 during the F.Y. 2003-04.
Sharjah-UAE
53 ITA Nos.4715 & 6086/Del/2010
50. As rightly contended, as per Section 37(1) of the Act, it is not necessary that the incurrence of the expenditure should always result in earning of profits and it can be for any purpose, even incidental or ancillary to the business, for which the expenditure may have been incurred, in order to be allowable under the provision. In the light of the details filed, since export has been shown to have been made to both the countries visited, the grievance raised by the department is found to carry no force at all. Accordingly, the CIT (A)'s findings in this regard are accepted and Ground no.4 is also rejected.
51. In this manner, the appeal filed by the Department for A.Y. 2004- 05 is dismissed.ITA No.6086/Del/2010
52. This is Department's appeal for Assessment Year 2005-06 against the order dated 26.11.2010 passed by the Ld. CIT (A)-XX, New Delhi. The sole grievance raised by the Department in this appeal is by way of Ground no.2, contending that the Ld. CIT (A) has erred in deleting the addition of ` 3,15,23,777/- made by the Assessing Officer on account of TPO adjustment, ignoring the facts brought on record by the TPO, as also the fact that Stanley, Japan and Stanley Electric Company, Japan are associate enterprises in the year under consideration.
53. The facts are that in its Form No.3CEB, for the year under consideration, the assessee reported the following international transactions:-
S.No. Description of transaction Value (in Rs.) 1 Import of raw material Rs.9,14,53,820/-
2. Import of fixed assets Rs.7,86,59,617/- 3 Payment of Royalty Rs.2,68,77,737/-
4 Payment of R&D Expenses Rs.11,10,173/-54 ITA Nos.4715 & 6086/Del/2010
54. The assessee had selected Transactional Net Margin Method (TNMM) as the most appropriate method for benchmarking of the international transactions at the entity level. The assessee had selected operating profit/operating revenue as the profit level indicator. In annexure 5 of the Report, the PLI of the assessee was computed at 6.5% and the PLI of the 4 comparables was computed at
-0.52%, on the basis of multiple year data. The current year margin of the comparables in Annexure 4 of the T.P. Report was shown at 7.55%.
On the basis of the above analysis, it was concluded that the international transactions were at arm's length price.
55. The TPO accepted the assessee's selection of the TNMM as the most appropriate method. The TPO observed that the data of the year 2003-04 was not considered to be appropriate for benchmarking the international transactions and so, the data for the year 2005 was only to be used. Taking Fiem Industries Ltd., Hella Indo Lighting Ltd., Jagan Lamps Ltd. and Phoenix Lamps Ltd. as the selected comparables, their current year average margin was taken at 7.55%. The TPO held the payment of royalty during the year to be unjustified, like in Assessment Year 2004-05, holding that the royalty payment related to providing of full time engineers of Stanley to the assessee company; that the assessee had purchased moulds, dyes and fixtures and designs and drawings, etc., from its AEs; that the assessee had imported goods from its AE and the payment of royalty for use of brand amounted to payment to self; and that the market intangible in the form of the brand name "Lumax" had been developed by the assessee in India after a long period of time and on heavy expenditure on R & D and advertisement, due to which, the payment of royalty for a long period of time since 1994 could not be taken as a plea to further justify the payment of royalty to the AE, even after 14 years, when the brand name "Lumax" was well established in the Indian automobile market.
55 ITA Nos.4715 & 6086/Del/2010The TPO also observed that the assessee had itself undertaken substantial research and had developed various new products for its domestic customers, due to which, it was unbelievable that any unrelated party would be willing to pay royalty to any other party; and that the assessee had failed to substantiate that any technology had actually been received, or even was required to be received from its AE. The TPO thus proposed an upward adjustment of ` 2,68,77,737/- to the total income of the assessee, being the difference in the arm's length price of the international transaction of payment of royalty. However, since addition of ` 3,15,23,777/- had already been proposed under TNMM, which, as per the Assessing Officer, included the amount of royalty paid by the assessee also, no separate addition on account of royalty was proposed. The income of the assessee was, accordingly, proposed to be enhanced by the amount of ` 3,15,23,777/-.
56. By virtue of the impugned order, the Ld. CIT (A) deleted the addition made by the Assessing Officer in pursuance of the TPO's order. The Ld. DR has reiterated the submissions made while arguing ITA No.4715/Del/2010 for Assessment Year 2004-05 (supra). The ld. counsel for the assessee has also stood by the corresponding arguments made by him for Assessment Year 2004-05.
57. The CIT (A), it is seen, while deleting the addition made, has held, as for Assessment Year 2004-05, that the TPO had erred in holding that the agreement between the assessee and Stanley was merely an agreement; that the TPO erred in disregarding that the assessee was into a commercial relationship with Stanley and the expatriate engineers had been sent to ensure that the technology supplied was properly applied; that mere obtaining of moulds, designs and drawings could not lead to disallowance of the royalty payment, since the technology for use thereof was what required the payment of royalty; that from the fact that the assessee's turnover had increased 56 ITA Nos.4715 & 6086/Del/2010 over the years and that the assessee was establishing its own R&D Centre and thereby trying to absorb the technology the company received from its AE, went to show that it could not be said that there was no transfer of intangible, or that no technology had actually been received, or was required to be received; that since Phoenix Lamps was an entity situated in an SEZ, enjoying certain benefits, being in an advantageous position as compared to the assessee, if it were to be retained as a comparable, certain adjustments were required to be made to it; that in Assessment Year 2006-07, the TPO had himself rejected Phoenix Lamps as a comparable; that so, Phoenix Lamps was being rejected as a comparable; that the remaining three comparables gave a PLI of 6.07% on the current year's basis; and that the assessee's PLI was at 6.50% and so, no adjustment was required to the arm's length results.
58. Here, it is seen, that like in Assessment Year 2004-05, the Ld. CIT (A) has correctly deleted the addition made and we uphold this action of the Ld. CIT (A) for the reasons similar to those recorded by us while dealing with ITA No. 4715/Del/2010 for Assessment Year 2004-05 (supra).
59. Accordingly, the order of the Ld. CIT (A) is upheld and the grievance sought to be raised by the department is rejected as being shorn of merit.
60. In the result, the appeal filed by the department for Assessment Year 2005-06 is dismissed.
57 ITA Nos.4715 & 6086/Del/201061. Consequently, both the appeals of the department, i.e., ITA No.4715/Del/2010 for Assessment Year 2004-05 and ITA No.6086/Del/2010 for Assessment Year 2005-06 are dismissed.
The order pronounced in the open court on 12.07.2013.
Sd/- Sd/-
[G.D. AGRAWAL] [A.D. JAIN]
VICE PRESIDENT JUDICIAL MEMBER
Dated, 12.07.2013.
dk
Copy forwarded to: -
1. Appellant
2. Respondent
3. CIT
4. CIT(A)
5. DR, ITAT
TRUE COPY
By Order,
Deputy Registrar,
ITAT, Delhi Benches