Income Tax Appellate Tribunal - Bangalore
M/S Toyota Kirloskar Motor (P) Ltd.,, ... vs Assessee on 11 July, 2014
IN THE INCOME TAX APPELLATE TRIBUNAL
"A" BENCH : BANGALORE
BEFORE SHRI N.V. VASUDEVAN, JUDICIAL MEMBER
AND SHRI RAJENDRA, ACCOUNTANT MEMBER
IT(TP)A No.1315/Bang/2011
Assessment year : 2007-08
M/s. Toyota Kirloskar Vs. The Assistant Commissioner of
Motor (P) Ltd., Income Tax, LTU,
Plot No.1, Bangalore.
Bidadi Industrial Area,
Ramanagar District,
Bangalore - 562 109.
PAN : AAACT 5415B
APPELLANT RESPONDENT
Appellant by : Shri Padamchand Khincha, C.A.
Respondent : Shri C.H. Sundar Rao, CIT-I(DR)
by
Date of hearing : 07.07.2014
Date of Pronouncement : 11.07.2014
ORDER
Per N.V. Vasudevan, Judicial Member
This appeal by the assessee is against the order passed on 21.10.2011 by the ACIT, LTU, Bangalore u/s. 143(3) r.w.s. 144C of the Income-tax Act, 1961 [hereinafter referred to as "the Act" in short"], incorporating the directions of the DRP dated 27.9.2011.
2. Though the assessee has raised about 30 grounds in its grounds of appeal filed along with Form 36B, ground No.12 & 22 to 24 raised therein was taken up for consideration. If the contention of the assessee on IT(TP)A No.1315/Bang/2011 Page 2 of 39 ground No.12, 22 to 24 is accepted, then the other issues raised in the grounds of appeal need not be gone into and those grounds would be left open for adjudication in the appropriate proceedings in the appropriate assessment year.
3. Gr.No.12, 22 to 24 raised by the Assessee in its grounds of appeal reads thus:
"The learned Assessing Officer, learned Transfer Pricing Officer and Honourable Dispute Resolution Panel have erred in Gr.No.12: not appreciating that the trading and manufacturing segments are intertwined and inter-related warranting a "combined Transaction Approach" in arriving at the arm's length price.
Gr.No.22: doing separate evaluation of royalty payment, technical fees and other payments by adopting CUP method without justifying how the same was most appropriate method.
Gr.No.23: Concluding that arm's length price of royalty payment, technical fees and other payments as NIL without brining on record any comparable;
Gr.No.24: Concluding that the taxpayer has not been able to show that it derived any economic benefit from the alleged know-how received from the associated enterprises ignoring the evidence supporting the same, which were on record;"
4. The assessee is a company. It is in the business of manufacture and selling Multi Utility Vehicles under the model name 'Innova' and passenger cars under the model 'Camry' and 'Corolla'. For the A.Y. 2007- 08, it filed a return of income on 19.10.2007, which was revised on 3.1.2008 declaring an income of Rs.118,56,65,783. In the course of assessment proceedings, the Assessing Officer noticed that the assessee is a subsidiary of Toyota Motor Corporation, Japan and has entered into international transaction with its holding company during the previous year. The transaction with the holding company was an international transaction IT(TP)A No.1315/Bang/2011 Page 3 of 39 with an Associated Enterprise (AE) and therefore the price at which the international transaction was carried out has to pass the Arm's Length price test laid down in Sec.92 of the Act.
5. As already stated the Assessee is a subsidiary of Toyota Motor Corporation, Japan (TMC), manufactures and sells multi-utility vehicles under model name "Innova" and passenger cars under the model name "Camry/Corolla."
6. During the previous year, the Assessee was engaged in carrying out two activities:
1. Manufacturing and
2. Trading The Financials of Assessee for the FY 2006-07 at the entity level relevant to AY 07-08 (Includes Transactions with AE as well as Non-AE) :
Description Rs. In
(000)
Operating Revenue (excluding other income) 37633754
Operating Expenses (excluding interest and loss on sale 36847765 of assets) Operating Profit (PBIT) 785989 OP on cost 2.13% OP on sales 2.09% The segmental results in respect of its trading segment and manufacturing segment were as under:-
Description Manufacturing Trading Rs. Total Rs.
Rs.
Operating Revenues 76.55% 23.45% 100%
Net Sales 2858,56,48,000 875,81,13,000 3734,37,61,000
Scrap Sales 28,99,93,000 0 28,99,93,000
2887,56,41,000 875,81,13,000 3763,37,54,000
Cost of Goods Sold / 2419,28,33,000 715,82,34,000 3135,10,67,000
Consumption of
Material
IT(TP)A No.1315/Bang/2011
Page 4 of 39
Gross Profit 468,28,08,000 159,98,79,000 628,26,87,000
Gross Profit on 16.22% 18.27% 16.69%
Sales
Other Expenses
Manufacturing 90,35,91,000 0 90,35,91,000
expenses
Expenses on 86,54,98,000 26,51,33,000 113,06,31,000
employees
Depreciation 94,24,11,000 0 94,24,11,000
Royalty 78,01,61,000 0 78,01,61,000
Other operating 133,18,97,000 40,80,07,000 173,99,04,000
Expenses
482,35,58,000 67,31,40,000 549,66,98,000
Total Cost 2901,63,91,000 783,13,74,000 3684,77,65,000
Operating Profit (-)14,07,50,000 92,67,39,000 78,59,89,000
(PBIT)
OP on Sales (-) 0.49% 10.58%
OP on Cost (-) 0.48% 11.83%
The above financials may not be relevant for the purpose of deciding the issues raised by the Assessee in Gr.No.12, 22 to 24 but has been given just to give a broad picture. The above details may be relevant
7. As already stated, the Assessee was engaged in the following activities:
1. Manufacturing and
2. Trading The Assessee purchases various spares and components from the Associated Enterprises, which form part of the Multi Utility Vehicle (MUV) and passenger car manufactured by the Assessee. The Assessee also made payments towards royalty as also for various services received from associated enterprises. The Assessee also purchases certain parts and components locally and exports the same to associated enterprises. The Assessee also imports CBU's and sells the same locally. The Assessee selected Transactional Net Margin Method(TNMM) as the most appropriate IT(TP)A No.1315/Bang/2011 Page 5 of 39 method. The TP analysis was done at the entity level combining all the transactions including those as a distributor. The Assessee in his transfer pricing analysis took as comparable companies 7 companies who had business similar to that of the Assessee i.e., they were also engaged in manufacturing of motor vehicles as well as trading in parts and accessories. The profit level indicator (PLI) adopted was cash profit to sales. The Assessee arrived at the cash and operating profit margin of the 7 comparable and arrived at an arithmetic mean of 5.28% and 2.87% respectively of cash profit margin and operating profit margin of the 7 comparable. The Assessee's cash profit margin and operating profit margin were arrived at 11.36% and 8.84% respectively. It was submitted by the Assessee that on a comparison at the entity level, the profit margins of the Assessee was much higher than the arithmetic mean of the comparable and therefore the international transaction with the AE should be considered as at Arm's Length.
8. The TPO was of the view that segmental financials demarcating Manufacturing segment and Trading segment are important for transfer pricing analysis at the segmental level. The segmental result as given by the Assessee as enclosure to one of the letter dated 27.1.2011 of the Assessee to the TPO was accepted by the TPO. Thereafter the TPO was of the view that while computing the operating margin in the manufacturing segment, the following items were not considered as part of operating revenues.
i. Interest from banks;
ii. Interest from others;
iii. Profit on sale/scraping of fixed assets;
IT(TP)A No.1315/Bang/2011 Page 6 of 39 The TPO also found that certain expenses had been treated as extraordinary and not considered while arriving at the margin of cash profit to sales. The following were the expenses that had been treated as extraordinary.
i. Abnormal warranty provision - Rs.4.7 crores ii, Write off of Qualis parts - Rs.3.676crores iii. Extraordinary gratuity provision due to change in accounting system -- Rs.2.202 crores.
9. After taking into consideration the above expenses as well as operating revenue, the TPO arrived at the segmental operating results for manufacturing and trading segments for the purpose of transfer pricing analysis.
Particulars Manufacturing Trading
(Rs. in crores) (Rs. in
crores)
Operating Revenues
Net sales 2916.42 817.96
Sale of scrap 26.3 0
Other operating income (Commission 7.17 0.06
and Foreign Exchange gain)
Commission 2.70
Exchange gain 0.23 0.06
Provisions no longer required written 1.28
back
Miscellaneous income 0.90
Insurance 2.05
Operating Revenue 2949.89 818.02
Expenses debited to P&L 2903.91 780.86
Less: Extraordinary expenses
Abnormal warranty provisions 4.7 0
Write off of quails parts 3,676 0
Extraordinary gratuity provision 2,202 0.617
Operating cost 2893.33 780.24
Operating profit 56.56 37.78
Operating profit margin on sales 1.94% 4.62%
IT(TP)A No.1315/Bang/2011
Page 7 of 39
The above segmental results were considered for transfer pricing analysis by the TPO. If the above segmental results are combined and taken at the entity level then the operating revenue would be Rs.3767.91 Crores and the operating profit would be Rs.94.34 crores giving a combined operating profit on sales of 2.517%. This may assume significance at a later point of time when a decision is taken as to whether the TP analysis has to be carried out at the segmental level or at the entity level.
10. The Assessee had carried out the following international transactions during the previous year:-
Sl Particulars Amount (Rs.)
No.
1 Purchase of spares and components 1089,86,95,168
2 Sale of spare parts and components 430,54,09,091
3 Payment and provision of Royalty 78,13,84,839
4 Payment technical assistance fees 76,63,572
5 Purchase of CBU 89,67,94,031
6 Return of racks 39,97,081
7 Sale of manufactured CBU 25,42,829
8 Sale of Prototypes and trial parts 2,93,000
9 Reimbursement towards warranty, sales 8,54,55,130
promotion etc
10 Payment towards traveling, boarding & 1,93,47,686
lodging etc
11 Payment towards sales promotion, advt, R&D 64,19,459
etc
12 Payment towards software & communication 28,35,218
expenses
13 Payment towards dealer training, sales 35,78,196
promotion and advt. material
11. The TPO was of the view that the action of the Assessee in doing TP analysis adopting TNMM by combining both manufacturing and trading activity was not correct as the two activities were distinct functions.
IT(TP)A No.1315/Bang/2011 Page 8 of 39 According to The TPO, the TP analysis has to be done at the manufacturing and trading segmental level by a separate transfer pricing analysis for trading and manufacturing. In this regard, the TPO was of the view that for analysing international transactions, most appropriate method is to be applied for each class of transaction. In this regard, he referred to Rule 10B(2) of the Income Tax Rules, 1962 (Rules) which reads thus:
"Most appropriate method.
10C(1) For the purposes of sub-section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an arms length price in relation to the international transaction.
(2) In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken into account, namely:
(a) the nature and class of the international transaction;"
According to the TPO, the most appropriate method is to be applied keeping in view the nature and class of transaction. Thus each class of' international transaction is to be analysed separately by applying the most appropriate method.
12. The TPO also held that the law provides for comparative analysis of the international transactions in TNMM on the basis of the net margin realized by the taxpayer during the year from the international transactions and not based on enterprise level earnings and in this regard referred to Sub clause (i) of clause (e) of Rule 10B(1) of the Income Tax Rules, 1962 (the Rules) is extracted below:-
"(i) the net profit margin realized by the enterprise from an international transaction entered into within associated enterprise is computed in relation to costs incurred or sales effected or assets IT(TP)A No.1315/Bang/2011 Page 9 of 39 employed or to be employed by the enterprise or having regard to any other relevant base." (Emphasis added) According to the TPO, from the above provisions it was very clear that the net margin realized by the enterprise during the year from the different class of international transactions computed as per the above said clause in TNMM is required to be taken. Hence, the comparison of margins at the enterprise level instead of the actual margin realized by the assessee company in the various segments was held by the TPO to be incorrect and not in accordance with the law providing for determination of the arm's length. The TPO emphasized the fact that when a taxpayer is involved in two distinct activities like manufacturing of passenger cars and trading in auto components which is evidenced by the segmental and other details available in the audited financials of the taxpayer these have to be analyzed separately by applying the most appropriate method in each case. Thereafter the TPO referred to the decisions of the ITAT, Mumbai in the case of Star (I) Pvt. Ltd. vs. ACIT [2008-TIOL-426-ITAT-Mum] and UCB(I) Pvt. Ltd. (317 ITR 292 (AT)(Mumbai) wherein aggregation of international transactions were not accepted and the TPO was directed to determine ALP of individual transactions. The TPO then concluded that transactions that have a bearing on profit can be analyzed separately and therefore the transactions of manufacturing segment and trading segment have to be considered separately for the purpose of transfer pricing analysis.
13. Thereafter the TPO classified the international transactions entered into by the taxpayer during the FY 2006-07 based on their nature as below:-
IT(TP)A No.1315/Bang/2011 Page 10 of 39
(i) Sale of spare parts and components - Manufacturing
(ii) Sale of prototypes and trial parts - Manufacturing
(iii) Sale of manufactured CBU - Manufacturing
(iv) Receipt of commission - Trading
(v) Return of racks - Manufacturing
(vi) Purchase of parts and components - Manufacturing and trading
(vii) Purchase of automobiles and accessories - Trading
(viii) Payment of royalty and technical fees - Manufacturing
(ix) Payment for intra group services - Manufacturing and trading
(x) Reimbursement of expenses received - Manufacturing and trading The TPO then proceeded to categorize the aforesaid transactions into two distinct segments:-
i. Manufacture and sale of passenger cars ii. Trading in auto components
14. Thereafter, the TPO arrived at the results of the trading segment as well as manufacturing segment of the assessee. The PLI adopted was operating profit on sales. As far as trading segment is concerned, the AO arrived at the following segmental results:-
Particulars Trading
(Rs. in crores)
Operating Revenues 818.02
Cost of Goods sold 715.82
Gross Profit 102.02
Gross Profit on Sales 12.49%
Operating Cost 780.24
Operating profit 37.78
Operating profit margin on sales 4.62%
IT(TP)A No.1315/Bang/2011
Page 11 of 39
The TPO was satisfied that the international transactions in the trading segments were at Arm's Length as the Assessee's profit margin was better compared to the profit margin of the comparable companies (in its trading segment) selected by the Assessee in it's TP study. No adjustment whatsoever was therefore suggested by the TPO in so far as it relates to the trading segment is concerned.
15. As far as manufacturing segment is concerned, the TPO as we have already seen had arrived at the operating profit margin on sales at 1.94% in the chart given at para-9 of this order. The taxpayer had identified 7 comparables at the enterprise level by taking manufacturing segment as well as trading segment results. The 7 comparables chosen by the assessee were as follows:-
Sl Name of the Company
No.
1 Ashok Leyland Limited
2 Eicher Motors Ltd.
3 Force Motors Ltd.
4 Hindustan Motors Ltd.
5 Mahindra & Mahindra Ltd.
6 Swaraj Mazda Ltd.
7 Tata Motors Ltd.
16. The TPO accepted 5 companies as comparables. One of the filters applied by the TPO was that the comparable company should have at least 75% of its revenue from manufacturing of these goods. For applying the above filter for choosing comparable companies, the TPO relied on para 1.20 (Under the head 'functional analysis') of the OECD Guidelines, 1995 which says that functional analysis is to identify and to compare economically significant activities undertaken by the independent IT(TP)A No.1315/Bang/2011 Page 12 of 39 enterprises. The relevant portion of the OECD Guidelines is reproduced below.
"1.20 In dealings between two independent enterprises, compensation usually will reflect the functions that each enterprise performs (taking into account assets used and risks assumed). Therefore, in determining whether controlled and uncontrolled transactions or entities are comparable, comparison of the functions taken on by the parties is necessary. This comparison is based on a functional analysis, which seeks to identify and to compare the economically significant activities and responsibilities undertaken or to lie undertaken by the independent and associated enterprises. For this purpose, particular attention should be paid to the structure and organisation of the group. It will also be relevant to determine in what juridical capacity the taxpayer performs its functions."
The Assessee submitted before the TPO that if the above filter is applied to comparable then the same should be applied to the taxpayer so as to combine manufacturing and trading as trading revenues in the case of taxpayer are also less than 25% of the revenues. The TPO however was of the view that trading and manufacturing are different activities associated with different asset and risk profile therefore the two activities cannot be combined. The Assessee pointed out that the comparable companies are also into trading and that the trading revenues in the case of comparable companies contribute less than 25% of revenues. The TPO however held that the impact on the overall profits of the comparable companies on account of trading revenues being less than 25% of the overall revenues was negligible.
17. Thereafter, the TPO arrived at the following arithmetic mean of the 5 comparable companies chosen in the manufacturing segment:-
IT(TP)A No.1315/Bang/2011 Page 13 of 39 (Rs. in Crore) Sl Company Finance Adj. Net Adj. Op. Adj. Op. Adj.
No Name Year Sales Cost Profit OP
/Sales
1 Ashok 2007- 7237.19 6789.24 447.95 6.19%
Leyland 08
2 Eicher 2007- 1932.90 1878.77 54.13 2.80%
Motors Ltd 08
3 Mahindra & 2007- 9552.32 8923.55 628.77 6.58%
Mahindra 08
Ltd.
4 Swaraj 2007- 576.38 565.08 11.30 1.96%
Mazda Ltd 08
5 Tata Motors 2007- 27004.49 24859.14 2145.35 7.94%
Ltd. 08
Arithmetical Mean Margin 5.10%
18. Thereafter, the TPO made the downward revision of the profit margins of the comparable on account of operating efficiency. In this regard the TPO was of the view that the operational efficiency is indicated by how an enterprise controls its operating expenses other than cost of raw material. Thus if an organization is able to control the indirect expenses like employee cost etc, its profitability improves. Thus, before comparing the taxpayer with the comparable companies, their efficiencies also have to be equalized. Otherwise, the comparability exercise would be distorted.
Adjustments have to be made for the differences in operational efficiency levels between the taxpayer and the comparable company. Thereafter the TPO drew the following conclusion with regard to the operational efficiency of the Assessee and that of the comparable companies.
Description Other Operative
Expenses as % of
Sales
Arithmetic Mean of Comparables (As per 19.64%
Annexure - C to the order of TPO)
Toyata-Kirloskar 16.07%
IT(TP)A No.1315/Bang/2011
Page 14 of 39
The TPO concluded that the operative efficiency of the Assessee vis-â-vis the comparable companies is higher by 3.57%. This difference according to the TPO was material as the margins of the comparable companies in this sector varied only from 3.52% on sales to 9.35% on sales for the FY 2006-
07. The TPO therefore proposed to increase the margins of the comparable chosen i.e., he revised the profit margins of the comparables so that they would be on par with the Assessee.
19. The Assessee however vehemently opposed such a course of action being adopted by the TPO. According to the Assessee adjustment on account of operating efficiency is not contemplated in law at all. In this regard the Assessee pointed out that there could be adjustments made for transaction level difference or an enterprise level difference. These differences can be either in the functions performed or assets employed or risks assumed. An operating efficiency does not fall within any of the parameters listed above. The Assessee also pointed out that under rule 10B(1)(e)(iii) of the Rules which provides for adjustment while computing margins under TNMM, no such adjustment for operating efficiency is contemplated. The relevant rule reads thus:
"Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :--
(a) to (d)......
(e)transactional net margin method, by which,--
(i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified;
(ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering IT(TP)A No.1315/Bang/2011 Page 15 of 39 into such transactions, which could materially affect the price in the open market;
(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;"
The Assessee pointed out that the rules contemplate only for an adjustment for transaction level differences or enterprise level differences. The Assessee submitted that the difference in operating expenses is neither difference in transaction nor enterprise. Besides other submissions relying on OECD Guidelines on why adjustment on account of operating efficiency should not be made, the Assessee submitted that under the TNMM comparison needs to be made at net profit level. By negating impact of operating expenses; the comparison is effectively being made at gross profit level instead of net profit level as required under TNMM. The Assessee also submitted that if operating efficiency is criteria for evaluation for selecting comparables, then companies with wide disparities in operating efficiencies cannot be compared at all. We are not going into the other elaborate submissions made by the Assessee in this regard as the issue raised in Gr.No.12 proceeds under the assumption that even if the adjustment on account of operating efficiency is given even then the margins of the Assessee if compared at entity level rather than at segmental level, will be well within the permitted (+) (-) 5% range of arithmetic mean PLI of the comparable companies chosen by the TPO.
20. The TPO did not agree with the submissions of the Assessee regarding upward adjustment of the margins of the comparable for the IT(TP)A No.1315/Bang/2011 Page 16 of 39 purpose of comparability and accordingly arrived at the margin of the comparables after making adjustments towards operational efficiency as follows:-
Sl Company Name Margin Margin after Difference No before adjustment adjustment 1 Ashok Leyland 6.19% 7.59% 1.40% 2 Eicher Motors Ltd 2.80% 8.58% 5.78% 3 Mahindra & 6.58% 13.03% 6.45% Mahindra Ltd.
4 Swaraj Mazda Ltd 1.96% - 6.15% -
8.11% 5 Tata Motors Ltd. 7.94% 12.45% 4.51% 5.10% 7.10% 2.00%
21. The TPO thereafter compared the net margin earned by the Assessee as computed by him in para-9 of this order on segmental basis for manufacturing segment to the Adjusted Net Margin earned by the comparable companies as follows:
PLI (Op to Sales) Arithmetic Mean of Adjusted Net Margin of 7.10% Comparables Toyata-Kirloskar Motor (the Assessee as 1.94% computed in para-9 of this order by the TPO on manufacturing segment) The TPO held that the margin earned by the Assessee was much less than the arithmetical mean margin earned by comparable enterprises and was beyond +/- 5% range from the price charged by the Assessee in its international transactions during the FY 2006-07. The TPO thus concluded that the international transactions entered into by the Assessee in the manufacturing segment was not at arm's length. The arm's length price was computed by him as under.
IT(TP)A No.1315/Bang/2011 Page 17 of 39 "Computation of Arm's Length Price The arm's length price is computed as under for the manufacturing segment:
Costs incurred in the international transactions (as per submissions of the taxpayer dated 25-02-2011) a. Purchase of parts & components Rs.1089,86,95,168 b. Payment of technical support fee Rs. 76,63,572 c. Other expenses Rs. 3,21,80,558 d. Royalty Rs. 78,13,84,839 Total cost incurred with AEs in the mfg segment ...... Rs.1171,99,324,137 Operating Revenues (a) Rs. 2949,89,00,000 Arms Length Mean Adjusted Operative Profit 7.10% on Sales Margin Total Arm's Length Operative Cost (92.90% of (a)) Rs. 2740,44,78,100
(b) Operative Cost shown in the books (c) Rs. 2893,33,00,000 Cost shown in the international transactions (as Rs. 1171,99,24,137 arrived above) (d) Costs incurred with un-associated enterprises / Rs. 172 1,33,75,863 persons (e = c - d) Arm's length cost of international transactions (f= b Rs. 1019,11,02,237
- e) Shortfall being adjustment u/s 92CA (g=d - f) Rs. 152,88,21,900 The above amount of Rs. 152,88,21,900 is considered as an adjustment U/s 92CA in the manufacturing segment."
22. Having categorized the international transactions of the Assessee with it's AE into manufacturing and trading segment and having held that both the profit margins of both the segments should not be taken together for comparability analysis at the entity level and having proceeded to determine the ALP of the manufacturing segment by taking the following international transactions as comprising in the manufacturing segment, IT(TP)A No.1315/Bang/2011 Page 18 of 39 a. Purchase of parts & components Rs.1089,86,95,168 b. Payment of technical support fee Rs. 76,63,572 c. Other expenses Rs. 3,21,80,558 d. Royalty Rs. 78,13,84,839 Total cost incurred with AEs in the mfg segment ...... Rs.1171,99,324,137 the TPO also took up the individually the four categories of international transactions comprised in the manufacturing segment for individual analysis. He was of the view that each of the aforesaid individual transactions were at arm's length except the transaction of payment of royalty. In this regard the TPO was of the view that the Assessee did not prove that benefit accrued as a result of payment for royalty. He therefore held that the royalty payments by the taxpayer for use of know how has to be taken at nil because:
1. The Assessee has not produced any evidence that it had actually received any technical know-how during the year from the AE.
2. There is no proof that the other group concerns or third parties are also charged identical royalty.
3. The Assessee has also not been able to show that it derived any economic benefit from the alleged know how received from the AE.
4. The profitability is much below the comparable companies.
The Arm's Length Price of royalty was determined at Rs.Nil by the TPO and an adjustment u/s.92CA of the Act of Rs.78,13,84,839/- was made by the AO. No separate addition was however made by the TPO because according to him this adjustment would merge with the overall adjustment of Rs. 152,88,21,900 made in the manufacturing segment by applying TNMM at the segment level.
IT(TP)A No.1315/Bang/2011 Page 19 of 39
23. Aggrieved by the order of the TPO which were incorporated by the AO in the draft order of assessment, the Assessee filed objections before the Disputes Resolution Panel (DRP). We deem it appropriate to set out the objections with regard to the issues that arise for consideration in Gr.No.12 and Gr.No.22 to 24 alone, as our decision at the first instance would be on those grounds and only if those grounds do not survive, the other grounds need to be gone into.
24. The objection of the Assessee with regard to the action of the TPO in not accepting the combined transaction approach adopted by the Assessee combining the profit margins of both the manufacturing and trading segments was (a) the conclusion of the TPO that the trading and manufacturing segment of the Assessee are distinct without appreciating that both the segments are intertwined and inter-related warranting a "combined transaction approach" in arriving at the arm's length price. (b) selecting comparables for the manufacturing segment companies which were engaged in both trading and manufacturing activities and without bifurcating the financial results of the comparable between trading and manufacturing segment. (c) not appreciating that the assessee had adopted the TNMM at the entity level, in which process, the payment for royalty and other services were considered as closely linked transaction and hence was subsumed into the expenditure and accordingly already considered.
25. The Assessee elaborated on the above main contentions by pointing out that it was set up in India to manufacture and sell MUV under the model name "Innova" and passenger car under the model name "Corolla". The IT(TP)A No.1315/Bang/2011 Page 20 of 39 Assessee has license to manufacture "Innova" and "Corolla" from Toyota Motor Corporation, Japan(TMC), which owns the above brands. The Assessee also imports Camry and sports utility vehicle (SUV) Land Cruiser Prado as (completed brought unit) CBU and sells the same in the Indian market. The Assessee also purchases various spares and components from TMC, which forms part of the MUV and passenger car. The Assessee received various support services from TMC. The Assessee also purchase certain parts and components locally and exports the same to associated enterprises. The Assessee submitted that it had applied TNMM at the entity level for the following reasons:
1. The transactions between the Assessee and its associated enterprises are two way i.e., purchase as well as sale of parts and components. The transactions are linked and interdependent;
2. The international transactions between the Assessee and its AE include both service and sale transactions;
3. The various activities are intertwined and inter-related. Part of the trading activities were prompted by and are a result of the manufacturing activities, including the warrant commitments;
4. The data in the public domain is not detailed enough to permit a comparison of the results at the transaction level;
5. In the peculiar circumstances of the operations involving various types of transactions entered into, towards achievement of a common goal, it is not possible to split the financial data to arrive at the net result from particular and individual transaction.
6. The data regarding comparable transactions are available only at the entity level and not at individual transaction level; and
7. The net profit at the entity level would broadly justify the intrinsic value of all the underlying transactions particularly when the organization views them as independent and integrated whole.
The assessee explained that it had accordingly bunched all the international transactions the segment level for determining the arm's length price.
IT(TP)A No.1315/Bang/2011 Page 21 of 39
26. The Assessee pointed out that Organisation for Economic Co- operation and Development (OECD) in its Commentary on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereinafter referred as "OECD Guidelines" for short) refers to this approach. Para 1.42 of the OECD Guidelines provide that ideally, in order to arrive at the best approximation of fair market value, the arm's length principle should be applied on a transaction by transaction basis ("Separate Transaction" approach). However, the OECD Guidelines further provide that a "Combined Transaction Approach" can be adopted in case the transactions are closed linked or continuous and they cannot be evaluated adequately on an individual basis. In such a situation, rather than assessing the arm's length terms of the transactions individually, these transactions could be evaluated together using the most appropriate method. The relevant observations are extracted hereinbelow:
"However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include 1. some long-term contracts for the supply of commodities or services, 2. rights to use intangible property, and 3. pricing a range of closely- linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. Another example would be the licensing or manufacturing know-how and the supply or vital components to an associated manufacturer,' it may be more reasonable to assess the arm's length terms {or the two items together rather than individually. Such transactions should be evaluated together using the most appropriate arm's length method or methods". (emphasis supplied)
27. The Assessee also drew the attention of the DRP to para 150 of OECD Guidelines on Transaction Profit Methods wherein it is observed as follows:
"In particular, sales revenue that is derived from uncontrolled activities (purchase from unrelated parties, sales to unrelated IT(TP)A No.1315/Bang/2011 Page 22 of 39 parties) should not be included in the determination or testing of the remuneration for controlled activities, unless the controlled and uncontrolled activities are so closely linked that they cannot be evaluated adequately on a separate basis. One example of the latter situation can sometimes occur in relation to uncontrolled after-sales services or sales of spare parts provided by a distributor to unrelated end-user customers where they are closely linked to controlled purchase transactions by the distributor (or resale to the same unrelated end-user customers. "
28. The Assessee submitted that based on the above guidelines sale services or sales are to be considered as closely linked to purchase transactions from AE even if the after sale services or sales are with unrelated parties. The Assessee pointed out that the proposal to evaluate after sales services (part of Intra Group services) separately was not feasible because those transactions with the AE are closely linked and should be evaluated together. The Assessee also pointed out that doing so would be in accordance with Rule 1O A( d) of the Income Tax Rules, 1962 (hereinafter referred as "Rules" for short) which defines "transaction" to include a number of closely linked transactions. Linked means something which is connected. It was submitted that the definition does not provide that the transactions should be identical or similar. Once the transactions are connected, they can be evaluated together.
29. Further the assessee also relied on para 2.73 of Australian Tax Office (ATO) Taxation Ruling 97/20 on International Transfer Pricing which provides that:
"Ideally, dealings between associated enterprises should be priced on a transaction by transaction basis. However, it is also recognised that if it is impractical to assess individual transactions (e.g., if such an approach would not address all the relevant aspects of the dealings between the parties that affect comparability), it may be more appropriate to consider a combination of transaction".
IT(TP)A No.1315/Bang/2011 Page 23 of 39 It was pointed out that para 2.74 provides when it would be appropriate to group the transactions. In para 2.74(1) it is observed as follows:
"Dealings between associated enterprises in a particular product may involve separate transactions for the product, the intangibles associated with the product, technical advice, management services and any other related matters. In dealings with independent parties, these various aspects may be rolled into a package deal with all the associated costs being included in the transfer price of the product.
The various aspects may need to be considered together to account properly for the costs and to prevent double counting.
If the independent dealings being considered as possible comparables cannot be disaggregated, it would generally be appropriate to group all the relevant transactions between associated enterprises so comparability to the uncontrolled party package deal transaction can be properly determined."
30. Based on the above submissions, the Assessee submitted that in its case it would be appropriate to aggregate all the transactions and adopt TNMM using the combined transaction approach at the entity level.
31. The Assessee reiterated that TNMM considers the net profit margin earned by an organization. Adjustments are made to the net profits to factor in the differences at the transaction level or the enterprise level. Adjustments are also made for difference in the accounting methodology. TNMM makes a comparison at the entity / global level and not at the transactional level. The merit of this method is that it is resilient to minor functional differences. As a result of this characteristic, examination is not made at the individual component level of income or expenditure that has been reckoned in arriving at the net profit. When a comparison is made at the macro (global) level, where multiple intertwined transactions exist, it is not possible to identify or pinpoint the contribution of each facet or IT(TP)A No.1315/Bang/2011 Page 24 of 39 transaction to the earning of net profit. The Assessee pointed out that in the process of adopting the TNMM, it adopted the Net Profit as the starting point. In arriving at this net profit, it had factored the royalty payments / management fee / intra group service fees. Once the net profit margin is demonstrated to be at arm's length, it pre-supposes that the various components of income and expenditure that have been considered in the process of arriving at the Net Profit are also at arm's length. The operating margins as computed by it are demonstrated to be at arm's length. Accordingly, the Assessee submitted that in its case the TNMM is to be applied at the entity level and not transaction level as proposed by your honour. The assessee drew attention of the TPO to the decision of the Hon'ble Pune ITAT decision in the case of Skoda Auto (I) Pvt. Ltd. vs. ACIT [2009-TIOL-214-ITAT-Pune] wherein on identical facts the TPO accepted aggregation of international transactions observing that when TNMM is used to bench mark the assessee's margin the ALP adjustment being made on that basis will adequately cover the excess expenditure on royalty and fees for technical know-how and hence no separate adjustment for the transactions of royalty and fees for technical know-how was required.
32. The Assessee also pointed out that the reliance placed by the TPO on the decisions of Mumbai Tribunal in the case of UCB India Pvt Ltd 317 ITR 292 (AT) and Star India Private Limited 2009-TIOL-426-ITAT-MUM to buttress the contention that he is empowered to apply appropriate method for each class of the transactions after applying the TNMM at the segment level, was not correct. In this regard the Assessee pointed out that in the case of UCB India, the assessee was a subsidiary of a Belgium company IT(TP)A No.1315/Bang/2011 Page 25 of 39 engaged in the business of manufacture and distribution of pharmaceutical products. The assessee had purchased active pharmaceutical ingredients from its AEs. The assessee applied TNMM at the entity level. The TPO applied CUP based on information received from certain competitors of the assessee u/s 133(6). Based on these facts the Tribunal held that TNMM cannot be applied at the entity level and should be applied to AE related segment. This was for the reason that the assessee was engaged in various activities other than AE transactions. The Tribunal also rejected the application of CUP method on the ground that it suffers from various deficiencies, infirmities and lack of information on comparability.
33. Similarly in case of Star India, the assessee was engaged in three distinct businesses viz distribution of star channels, marketing for advertisement sales and content development for television programmes. The TPO in that case clubbed the three distinct businesses and determined ALP. It was not demonstrated by the TPO that the activities are closely linked. The assessee demonstrated that the activities are independent activities. In that context it was held that ALP is to be determined for each segment separately. In this case, the Tribunal relying on the Bangalore Special Bench Decision in the case of Aztec Software and Technologies Limited 107 ITD 141 (SB)(Bang.) held that where transactions are closely linked that have to be evaluated together. The relevant observations are extracted below:
"64. We have thoroughly examined the order of the Special Bench in the case of Aztec Software and Technologies Ltd. (supra) and we find that the Tribunal has examined the Chapter-X of the Income tax Act, relating special provisions relating to avoidance of tax in detail and the Tribunal has held that ideally in order to arrive at the most precise approximation of fair market value arms length principle IT(TP)A No.1315/Bang/2011 Page 26 of 39 should be applied on transaction to transaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be adequately dealt with on a separate basis. The Tribunal has also held that the burden of proving and establishing Arms Length Price and to furnish the relevant information lies initially on the assessee."
34. The assessee submitted that the decision in the case of Aztec Software (supra) is binding and needs to be followed.
35. The assessee reiterated that it had already demonstrated that all its activities are closely linked and interdependent. The assessee submitted that the decisions in the case of Star and UCB India are applicable only when the activities clubbed are dissimilar or are not closely linked. It was submitted that even otherwise, the Tribunal in the above cases has nowhere held that after applying TNMM at entity level, an item out of that segment can be separately evaluated. The observations of the ITAT do not support the proposition adopted by the TPO in the instant case. The conclusion is therefore without basis and ought to be rejected.
36. With regard to the action of the TPO in applying TNMM to the manufacturing segment and making an addition on account of ALP and thereafter separately evaluating the royalty transaction, which was also considered as part of the manufacturing segment, the assessee submitted that the action of the AO in segregating the royalty transaction from the manufacturing segment results was not in accordance with law. In this regard, it has to be mentioned that after segregating the royalty transaction, the TPO upheld CUP method of determining ALP and arrived at an ALP of Rs. NIL on the ground that the assessee has not been able to show that it IT(TP)A No.1315/Bang/2011 Page 27 of 39 had received any economic benefit and also for the reason that assessee did not produce any evidence to show that it had actually received technical know-how during the year. It was submitted by the assessee that the details of royalty payments along with the agreements had been submitted before the TPO. The assessee pointed out that as per the agreement, royalty at 6% on manufacture of licenced products and 3% on accessories, spares and components was to be paid by the assessee. This is a standard agreement adopted by the TMC for calculation of royalty payable for use of know-how. The assessee, however, paid only 5% which is less than the standard rate charged. The assessee submitted that the TPO proceeded ignoring the business realities. It was submitted that the assessee's very existence was based on know-how provided by the AE and there was no alternative source from which automobile technology could be sourced or obtained. The assessee also placed reliance on the decision of the Mumbai ITAT in the case of Dresser Rand (India) Pvt. Ltd. v. ACIT, ITA No.8753/MUM/2010, wherein the Tribunal held that the TPO cannot compute ALP at NIL on the ground that no real services were received by the assessee or that the assessee has not received any benefit under cost contribution arrangement. The following observations were brought to the notice of the DRP.
"We find that the basic reason of the Transfer Pricing Officer's determination of ALP of the services received under cost contribution arrangement as 'NIL' is his perception that the assessee did not need these services at all, as the assessee had sufficient experts of his own who were competent enough to do this work. For example, the Transfer Pricing Officer had pointed out that the assessee has qualified accounting staff which could have handled the audit work and in any case the assessee has paid audit fees to IT(TP)A No.1315/Bang/2011 Page 28 of 39 external firm. Similarly, the Transfer Pricing Officer was of the view that the assessee had management experts on its rolls, and, therefore, global business oversight services were not needed. It is difficult to understand, much less approve, this line of reasoning. It is only elementary that how an assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an assessee and what is not. An assessee may have any number of qualified accountants and management experts on his rolls, and yet he may decide to engage services of outside experts for auditing and management consultancy; it is not for the revenue officers to question assessee's wisdom in doing so. The Transfer Pricing Officer was not only going much beyond his powers in questioning commercial wisdom of assessee's decision to take benefit of expertise of Dresser Rand US, but also beyond the powers of the Assessing Officer. We do not approve this approach of the revenue authorities. We have further noticed that the Transfer Pricing Officer has made several observations to the effect that, as evident from the analysis of financial performance, the assessee did not benefit, in terms of financial results, from these services. This analysis is also completely irrelevant, because whether a particular expense on services received actually benefits an assessee in monetary terms or not even a consideration for its being allowed as a deduction in computation of income, and, by no stretch of logic, it can have any role in determining arm's length price of that service. When evaluating the arm's length price of a service, it is wholly irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined in such cases is whether the price of this service is what an independent enterprise would have paid for the same. Similarly, whether the AE gave the same services to the assessee in the preceding years without any consideration or not is also irrelevant. The AE may have given the same service on gratuitous basis in the earlier period, but that does not mean that arm's length price of these services is 'nil'. The authorities below have been swayed by the considerations which are not at all relevant in the context of determining the arm's length price of the costs incurred by the assessee in cost contribution arrangement."
IT(TP)A No.1315/Bang/2011 Page 29 of 39
37. The DRP on the issue of conclusions of the TPO that the trading and manufacturing segment of the assessee are distinct and not inter-related warranting combined transaction approach, held as follows:-
"The facts, arguments and contentions of the Eligible Assessee have been considered and deliberated upon in great detail after giving due opportunities in a speaking manner by the Transfer Pricing Authority. For economy of words, the same are not being replicated in this order. However there is no reason for any deviation from the position taken by the Transfer Pricing Officer in the given context. Moreover, the context of the eligible assessee before the Dispute Resolution Panel are mere repetition of those put forth before the Transfer Pricing Officer. As such, there is no fresh reason for reconsideration of the matter.
No interference is called for on this account."
38. With regard to the action of the TPO in determining the royalty payment at NIL, the DRP upheld the order of the TPO. Reasons given by the DRP in this regard are identical to the reasons given for rejecting the claim of the assessee for a combined transaction approach set out in the earlier paragraph. The DRP also made an observation that similar issues were sub-judice before different higher appellate and judicial forums and taking any other view would prejudice the pending proceedings on the issue for the revenue.
39. Aggrieved by the aforesaid directions of the DRP, the assessee has raised ground No.12, 22 to 24 before the Tribunal.
IT(TP)A No.1315/Bang/2011 Page 30 of 39
40. We have heard the submissions of the learned counsel for the assessee and the learned Departmental Representative. The submissions of the learned counsel for the assessee were reiteration of the stand of the assessee before the Revenue authorities besides reliance on some decisions of ITAT and Hon'ble High Court. The learned Departmental Representative relied on the order of the TPO, DRP and the AO. It was further submitted that the TPO can hold that the ALP of an international transaction is Nil.
41. We have given a very careful consideration to the rival submissions. On the issue as to whether the international transactions have to be considered separately or independently without aggregating them as part of the segment to which they relate, we find that the term 'international transaction' has been defined in section 92B of the Act to mean and include transactions between two or more AEs, either or both of whom are non- residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money or any other transaction having bearing on the profits, income, losses or assets of such enterprise. Section 92 of the Act provides that income from international transactions between AEs shall be computed having regard to ALP. Section 92-C of the Act prescribes the methods of determining ALP, having regard to the most appropriate method which will be decided in accordance with the rules prescribed. Rule 10A(d) of the Income-tax Rules 1962 ['the Rules'] provides that 'transaction' would include a number of closely linked transactions. Rule 10B(1)(d) of the Rules advocate profit split method of determining ALP where international transactions involve transfer of unique intangible or in multiple international transactions which IT(TP)A No.1315/Bang/2011 Page 31 of 39 are so inter-related that they cannot be evaluated separately for the purpose of determining ALP of any one transaction. It thus appears that the Act and the Rules contemplate determining ALP by aggregating international transactions which are multiple, interlinked or inter-related to each other and cannot be evaluated separately. To this extent the conclusions of the TPO regarding determination of ALP by taking segmental results without looking into as to whether the two segments are interlinked or inter-related cannot be sustained. As to what would be the most appropriate method in such cases is again dependent on Rules 10B(2) and (3) of the Rules.
42. The OECD guidelines as well as the Australian Tax Officer (ATO) Taxation Rule 97/20 on International Transfer Pricing para.2.74(1) referred to by the assessee before the Revenue authorities which have been set out in the earlier part of this order seems to support 'combined transaction approach' where the transactions are closely linked or continuous that they cannot be evaluated adequately on an individual basis. In such a situation, rather than assessing the ALP of the transactions individually, the transactions could be evaluated together using the most appropriate method.
43. The above being the legal position, it becomes necessary to examine the international transactions carried out by the assessee with its AE during the previous year which have been categorized into 2 segments by the TPO in his order and find out if they are interlinked or interconnected so that the transactions need to be evaluated together rather than individually. In this regard, we find that the submissions made by the Assessee before IT(TP)A No.1315/Bang/2011 Page 32 of 39 TPO as well as before DRP have not been considered at all. The TPO proceeded on the basis that ALP of each transaction has to be examined independently/individually by placing reliance on the decisions of Tribunal in the case of Star India Ltd. (supra) and UKB(I) (P) Ltd. (supra). We agree with the submissions of the learned counsel for the assessee that these decisions have in fact accepted in principle that aggregation of transactions have to be done where they are interlinked but have on facts found that transactions were not interlinked and therefore held that ALP of transactions have to be determined individually. The following decisions relied upon the learned counsel for the assessee also supports the plea of the learned counsel for the assessee. :
i. M/s.Thyssen Krupp Industries vs. ACIT (ITA No.7032/Mum/2011), ii. Hindustan Unilever Ltd. vs. ACIT (ITA No.7868/Mum/2010), and iii. DCIT vs. CMA CGM Global India (P) Ltd. (ITA No.5979/Mum/2010)
44. The DRP without examining the submissions on behalf of the assessee has simply endorsed the findings of the TPO. With regard to the conclusions of the DRP, upholding the order of the TPO that the trading and manufacturing segment of the assessee are distinct and not inter- related warranting combined transaction approach, the ld. counsel for the assessee drew our attention to the order of the Tribunal in assessee's own case for A.Y. 2003-04 in ITA No.828/B/2010, wherein identical issue was considered and decided by this Tribunal as follows:-
"14.5.2 Taking into consideration the submissions made and the facts and circumstances of the case, we agree with the submissions of the learned counsel for the assessee. While it is true that function, assets and risks of the trading and IT(TP)A No.1315/Bang/2011 Page 33 of 39 manufacturing segments generally differ, however circumstances may warrant combining both of them. It is only in the specific facts of the case that the combining of both segments is advisable. In the instant case of the assessee, the sale of spare parts is triggered as a result of the manufacturing activities, including warranty commitments. Therefore, we are of the view that it would not be in the fitness of things for the sale of spare parts and components to be considered in isolation from the sale of manufactured vehicles. This view is supported by the OECD T.P. Guidelines, 2010, relied on by the assessee. This view is also buttressed by the fact that the comparable companies are also trading in spare parts and components. On a overall consideration, it can be concluded that trading in spare parts is closely inter-linked with the manufacturing segment of the assessee. We are of the view that no meaningful purpose would be served in segregating the trading and manufacturing segments, particularly when the assessee and the comparable companies are at par with regard to the nature and scale of combined activities. Needless to add that this finding / decision by its very nature has to be case-specific and year-specific as the decision is based on the facts and circumstances of this particular case and of this particular year and is not to be construed as laying down the principle in this regard. We, therefore, direct the Assessing Officer / TPO to compute the ALP at the entity / enterprise level by combining the trading and manufacturing segments."
45. It is no doubt true that the Tribunal has observed that the ruling given in that year is based on the facts that prevailed in that year. We find that the facts in the present assessment year are also identical and there has been no change whatsoever in the business model of the assessee. In these circumstances, we are of the view that the decision rendered by the Tribunal would be applicable for this assessment year also. Respectfully following the decision of the Tribunal, we hold that the trading and manufacturing segment of the assessee are not distinct and are inter- related warranting combined transaction approach.
46. We have already seen in para 9 of this order that the TPO has arrived at the bifurcation of the manufacturing and trading segmental operating results. In view of our conclusions that the trading and IT(TP)A No.1315/Bang/2011 Page 34 of 39 manufacturing segments are interlinked and therefore a combined transaction approach has to be adopted, we combine the results so arrived at by the TPO, which is given in para 9 of this order. If the segmental results are combined, the operating revenue of the assessee would be 3767.91 crores and the operating profit would be Rs.94.34 crores. Thus, the operating profit margin on sales would be 2.517.
47. Even assuming that the adjustment on account of operational efficiency made by the TPO is to be accepted, then the combined margin after adjustment of the five comparables which is given in para-20 of this order, would be 7.10%. If the arithmetic mean of the five comparables as above is tested as against the operating profit margin on sales of the assessee at 2.517%, then the same would be within the (+)/(-) 5% range of the arithmetic mean and therefore no addition by way of adjustment to the ALP can be made. In this view of the matter, we are of the view that the addition sustained by the DRP deserves to be deleted and is hereby deleted. Gr.No.12 is accordingly allowed
48. On the issue whether the TPO can come to a conclusion that the ALP of an international transaction is nil because no services were rendered or that the assessee did not derive any benefit from the AE for which payments were made, we have considered the submissions of the learned counsel for the assessee. This issue is purely academic because we have already held that the conclusions of the TPO/DRP that the trading and manufacturing segment of the Assessee are distinct and not inter related warranting combined transaction approach is not correct and that a IT(TP)A No.1315/Bang/2011 Page 35 of 39 combined transaction approach has to be adopted and that on the basis of combined transaction approach the price paid for the international transaction is at Arm's Length. We may also that legally the TPO should adopt the ALP as nil. On similar approach by TPO adopting ALP at Nil the ITAT, Bangalore Bench, in the case of M/s.Festo Controls Pvt. Ltd. vs. DCIT in ITA No.969/Bang/2011 (AY: 2007-08) dated 4-1-2013, the Tribunal examined the question as to whether the TPO can determine the ALP at nil on the ground that no services were rendered. The Tribunal, on the above issue followed the decision of the Mumbai Bench of the ITAT in the case of Castrol India Ltd. v. ACIT in ITA No.3938/MUM/2010 dated 14.09.2012 wherein it was held that it was incumbent upon the TPO to work out the ALP of the relevant transactions by following some authorized method and the entire cost borne by the assessee cannot be disallowed by taking the ALP at Nil. The Tribunal also referred to the decision of the Hon'ble Delhi High Court in the case of CIT v. EKL Appliances Ltd., ITA No.1068/2011 dated 29.03.2012. In the aforesaid decision, the assessee entered into an agreement pursuant to which it paid brand fee/ royalty to an associated enterprise. The TPO disallowed the payment on the ground that as the assessee was regularly incurring huge losses, the know-how/ brand had not benefited the assessee and so the payment was not justified. This was reversed by the CIT (A) & Tribunal on the ground that as the payment was genuine, the TPO could not question commercial expediency. On appeal by the department, the Hon'ble Delhi High Court held that the "transfer pricing guidelines" laid down by the OECD make it clear that barring exceptional cases, the tax administration cannot disregard the actual transaction or substitute other transactions for them and the examination of IT(TP)A No.1315/Bang/2011 Page 36 of 39 a controlled transaction should ordinarily be based on the transaction as it has been actually undertaken and structured by the associated enterprises. The guidelines discourage re-structuring of legitimate business transactions except where (i) the economic substance of a transaction differs from its form and (ii) the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. The OECD guidelines should be taken as a valid input in judging the action of the TPO because, in a different form, they have been recognized in India's tax jurisprudence. The Hon'ble Court held that it is well settled that the revenue cannot dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur (Eastern Investment Ltd 20 ITR 1 (SC), Walchand & Co 65 ITR 381 (SC) followed). Even Rule 10B(1)(a) does not authorise disallowance of expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same. In light of the aforesaid decisions, we are of the view that the stand taken by the assessee in this regard deserves to be accepted. It is clear from the decisions referred to above that the TPO has to work out the ALP of the international transaction by applying the methods recognized under the Act. He is not competent to hold that the expenditure in question has not been incurred by the assessee or that the assessee has not derived any benefits for the payment made by the assessee and therefore he cannot consider the ALP as NIL. We hold accordingly.
IT(TP)A No.1315/Bang/2011 Page 37 of 39
49. Besides the above, even on facts the determination of ALP at NIL in respect of royalty payments cannot be sustained. In this regard, it was brought to our notice by the ld. counsel for the assessee that similar payment made in A.Y. 2009-10, the DRP in its directions dated 19.11.2013 was pleased to hold that the payment of royalty was supported by the services rendered by the AE and was justified. The aforesaid order of the DRP was considered by the CIT(A), LTU, Bangalore in A.Y. 2005-06 and in her order dated 20.3.2014, the CIT(A) held as follows:-
"10.3 The above mater had come up for adjudication before the DRP in the appeals for other years also. For AY 2006-07 I find that the DRP has confirmed the TPO's determination of ALP of royalty at 'nil' through order dt. 30.09.2010. In this order, however, at page 10 while recording its directions, the DRP mentions the TPO's admission that in view of the time barring situation he was unable to examine the objections raised by the assessee. After independently studying these objections, the DRP cryptically approved the TPO's position of 'nil' ALP. In AY 2009-10 however, the DRP has discussed in elaborate detail the assessee's objections on similar grounds and has arrived at the conclusion that the assessee not only received the technology support as well as the related intangibles in terms of production processes, but has also benefitted from these technological practices, standards and know-how which were not created locally by itself. The Toyota Production System, standardized on a world-wide basis, has also been studied for its operational efficiency by premier academic institutions. I am inclined to agree with this conclusion after examining the facts of the appellant's case and the evidences available. The TPO's argument that no benefit was derived by the appellant from the technology for which royalty was paid is not supported by facts and evidences. The fact that the royalty rate was within the permissible limit specified by the Govt. of India and approved by the RBI is an additional argument in support of the legitimacy of the said payment.
10.4 In view of the above discussion, the TPO's determination of the ALP of the royalty payment at 'nil' cannot be supported. For such ALP determination, a proper analysis of comparables is required to be performed for FY 2004-05 and the TPO is directed to identify suitable comparables and, after providing adequate opportunity to the appellant to determine the appropriate ALP of royalty payment. For statistical purposes, the grounds raised in this regard are treated as allowed."
IT(TP)A No.1315/Bang/2011 Page 38 of 39
50. The facts and circumstances remain the same in the present assessment year as it prevailed in the earlier assessment year decided by the CIT(A)/DRP referred to above. We are of the view that the findings of the CIT(A)/DRP have to be upheld and is accordingly upheld. In view of the above, we are of the view that Gr.No.22 to 24 has to be allowed, though it is only academic.
51. In view of our conclusions on Gr.No.12, 22 to 24, we are of the view that the other issues raised by the assessee in the various grounds of appeal do not require any adjudication and are left open.
52. In the result, the appeal by the assessee is allowed.
Pronounced in the open court on this 11th day of July, 2014.
Sd/- Sd/-
( RAJENDRA) ( N.V. VASUDEVAN )
Accountant Member Judicial Member
Bangalore,
Dated, the 11th July, 2014.
/D S/
IT(TP)A No.1315/Bang/2011
Page 39 of 39
Copy to:
1. Appellant
2. Respondent
3. CIT
4. CIT(A)
5. DR, ITAT, Bangalore.
6. Guard file
By order
Assistant Registrar
ITAT, Bangalore.