Income Tax Appellate Tribunal - Delhi
Hero Honda Motors Ltd., New Delhi vs Assessee on 27 October, 2010
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH 'C
'C' : NEW DELHI
BEFORE SHRI G.D.AGRAWAL,
G.D.AGRAWAL, VICE PRESIDENT AND
SHRI CHANDRA MOHAN GARG,
GARG, JUDICIAL MEMBER
ITA No.5130/Del/2010
No.5130/Del/2010
Assessment Year : 2006-
2006-07
M/s Hero MotoCorp Limited, Vs. Additional Commissioner of
34, Community Centre, Income Tax,
Basant Lok, Range-
Range-12,
Vasant Vihar, 3rd Floor, C.R.Building,
New Delhi - 110 057. I.P.Estate,
PAN : AAACH0812J. New Delhi.
(Appellant) (Respondent)
Appellant by : Shri Ajay Vohra, Advocate with
Shri Neeraj jain, Advocate and
Shri Ramit Katyal & Shri Gaurav
Jain, CAs.
Respondent by : Shri Piyush Jain, CIT-DR.
ORDER
PER G.D.AGRAWAL, G.D.AGRAWAL, VP :
This appeal by the assessee is directed against the order of the Assessing Officer dated 27th October, 2010 passed in pursuance of the order of the Dispute Resolution Panel ('DRP') dated 30th September, 2010.
2. At the time of hearing before us, it was stated by the learned CIT-DR that ground Nos.1 to 5 are the transfer pricing issues and ground No.6 onwards are corporate issues. He suggested that the 2 ITA-5130/Del/2010 corporate issues may be considered first. Accordingly, we proceeded to decide the corporate issues first.
3. Ground Nos.6 & 6.1 of the assessee's appeal read as under:-
"6. That the assessing officer erred on facts and in law in treating the total expenditure, aggregating to Rs.22,490.58 lacs (including cess and Rs.408.32 lacs treated by the TPO as not at arms' length price), incurred during the year on account of royalty and technical guidance fees paid to Honda Motor Co., Japan, ('Honda') in accordance with the 'License and Technical Assistance Agreement' ("LTAA") as capital expenditure.
6.1 Without prejudice, that the assessing office erred on facts and in law in treating 100% expenditure incurred on account of royalty and technical guidance fees as capital expenditure as opposed to 25% thereof being treated as capital expenditure in earlier years, which was, in any case, excessive."
4. The facts of the case are that the assessee derives income from manufacture and sale of motorcycles and spare parts. For the year under consideration, the assessee claimed the deduction of `22,940.58 lakhs as royalty payment which included the royalty of `408.32 lakhs paid on exports made to the associated enterprises. The TPO, vide his order dated 30th October, 2009, has held the royalty of `408.32 lakhs paid to AEs not at arm's length and, accordingly, the same was disallowed. The balance royalty of `22,082.26 lakhs (22,490.58 - 408.32) is disallowed by the Assessing Officer holding the same as capital expenditure. However, the Assessing Officer allowed depreciation at the rate of 25% thereon. Accordingly, the net disallowance was determined at `16,970 lakhs. The DRP, vide order dated 30th September, 2010, sustained the disallowance. Accordingly, the assessee is in appeal vide ground Nos.4, 6 & 6.1 of its appeal.
3 ITA-5130/Del/2010
5. At the time of hearing before us, the learned counsel for the assessee, in addition to the detailed arguments, has also furnished the synopsis of his arguments. For ready reference, we reproduce the same herein below:-
"The assessee is engaged in the business of manufacture and sale of motorcycles using technology licensed by Honda Motor Co.Ltd., Japan ("Honda") against payment of royalty and technical guidance fee in accordance with License and Technical Assistance Agreement, dated 02.06.2004 and subsequent supplementary agreements thereof ("the agreement"). (refer pages 462-508 to of paper book I). the agreement between the assessee and Honda provides for the latter to grant the assessee an indivisible and non-transferable right and license to manufacture, assemble, sell and distribute the products and parts during the term of the agreement within the specified territory.
During the relevant previous year, in terms of the aforesaid agreement, the assessee paid Rs.22,302.43 lacs (including cess thereon) as royalty and Rs.188.15 lacs (including cess thereon) as technical guidance fee to Honda.
In the assessment order, the assessing officer treated the aforesaid expenditure incurred by way of royalty and technical guidance fee paid to Honda as capital expenditure on the ground that :
1) The assessee has received benefit of enduring nature inasmuch as exclusive right was available to the assessee to manufacture and sell the products within the territory of India;
2) The assessee was entitled to continue the use of information supplied by Honda even after termination of agreement;
3) Payment also covered consideration of setting up of manufacturing facility of the assessee;
4) The benefit under the agreement had a degree of perpetuity since the agreement was renewed and was 4 ITA-5130/Del/2010 extended year after year and did not, therefore, remain a short term agreement.
5) The assessee has acquired asset in the nature of intellectual property rights and patent from Honda.
For the aforesaid reasons, while relying upon the decision of the apex Court in the case of Southern Switch Gear Ltd. vs. CIT : 232 ITR 359 and Jonas Woodhead & Sons (India) Ltd. vs. CIT : 224 ITR 342, it was held by the assessing officer that the said expenses incurred by the assessee constitutes capital expenditure.
On the basis of transfer pricing report, where royalty paid on exports, to the extent of Rs.408.32 lacs, was held to be not at arm's length, the assessing officer considered the aforesaid amounts as fully disallowable and allowed depreciation at 25% on the balance expenditure. Consequentially, the assessing officer made the net disallowance of Rs.16,970 lacs, after allowing depreciation @ 25%.
The disallowance made by the assessing officer on the aforesaid grounds is incorrect, both on facts and in law, for the reasons elaborated hereunder:
a. Brief History and Facts :
The assessee had set up its plant in the year 1984 to manufacture models of motorcycles by using know-how of Honda Motor Co. through Technical Collaboration Contract dated 24th January, 1984. Under that agreement, the assessee was provided with technical assistance not only for manufacture, assembly and service of the products but was also provided with information, drawings and designs for the setting up of the plant. The assessee was required to pay lump sum amount of $5,00,000 in consideration of technical information for construction of plant, which was capitalized in the books of account and no part thereof was claimed as revenue expenditure.
The aforesaid agreement expired in 1994. The agreement, prevailing during the relevant assessment year, was entered on 2.6.2004 on fresh terms for a further period of ten years and had no relation with the erstwhile 5 ITA-5130/Del/2010 agreement(s). The same cannot be said to be simple continuation of the earlier agreement executed in 1984.
The know-how licensed by Honda under the subject agreement of 2004 related only to manufacture, assembly inspection, maintenance etc., of products and was not for establishment of the factory. No plant was set-up nor extension to the existing plants was made through the assistance of Honda after the expiry of agreement of 1984. The payments by way of model fees and running royalty were made only towards limited license to use the know- how provided by Honda for manufacture of various models of motorcycles and no part of royalty paid during the year was for setting-up of plant.
b. No ownership rights - only li limited mited right to use :
Further, during the currency of the agreement, the assessee only had a limited right to use the technically of Honda. The ownership/proprietary rights in the technical know-how continued to vest in Honda and the assessee was not authorized to transfer, assign or convey the know- how/technical information to any third party and, therefore, the assessee acquired a limited right to use and exploit the know-how.
c. No exclusive license :
The aforesaid right vested with the assessee was not exclusive in as much as, in terms of Article 2 of LTAA, Honda reserved the right to provide technology to manufacture motorcycles by Honda Motorcycle and Scooters India Ltd. (''HMSI').
Payment under the agreement - allowable revenue expenditure :
Having regard to the various clauses of the agreement, it would be appreciated that the royalty payable to Honda is only for the purpose of use of technical assistance in the manufacture and sale of products and the assessee has not acquired any capital asset, much less in the nature of intellectual property rights or patents belonging to Honda, which was to continue to vest in the absolute ownership of the Honda, as provided in unequivocal terms in the agreement.
6 ITA-5130/Del/2010 It will be appreciated that in the case of acquisition of technical know-how, etc., unlike in the present agreement, the acquirer is free to use the rights acquired in the manner he likes and has the right to dispose of such rights. There are no restrictions or obligations on the acquirer as to secrecy, disposal, inspection of facilities, returning the technical know how, etc. Similarly no asset was acquired on payment of technical guidance fees, paid @ US$ 650 per diem in respect of services provided by technicians deputed by Honda in order to guide or solve the problems arising to the assessee company, while manufacturing the licensed products. The payment of guidance fees does not result in creation of any new asset nor result in any benefit of enduring nature. The said payment, was allowable expenditure under section 37(1) of the Act, being incurred for the purposes of business.
Reliance in this regard is placed on the following decisions wherein it has been held that where payment is made to simply use the technical know how/knowledge provided by the foreign collaborator as opposed to acquisition of ownership rights therein, the payment made would be regarded as revenue expenditure.
• CIT vs. Ciba India Ltd. : 69 ITR 692 (SC). • CIT Vvs. British India Corp. Ltd. [1987] 165 ITR 51 (SC). • Alembic Chemical Works Co.Ltd. v. CIT : 177 ITR 377 (SC). • Shriram Refrigeration Industries Ltd. vs. CIT : 127 ITR 746 (Del HC). • Triveni Engineering Works Ltd. vs. CIT : 136 ITR 340 (Del). • Addl. CIT vs. Shama Engine Valves Ltd. : 138 ITR 217 (Del). • CIT vs. Bhai Sunder Dass & Sons P.Ltd. : 158 ITR 195 (Del). • CIT vs. Lumax Industries Ltd. : 173 Taxman 390 (Del). • Shriram Pistons & Rings Ltd. vs. CIT : 171 Taxman 81 (Del). • CIT vs. Shri Ram Pistons and Rings Ltd. : 220 CTR 404 (Del). • Goodyear India Ltd. vs. ITO : 73 ITD 189 (Del)(TM). • ITO vs. Shivani Locks : 118 TTJ 467 (Del). 7 ITA-5130/Del/2010 • Climate Systems India Ltd. vs. CIT : 319 ITR 113 (Del- HC). • CIT vs. Sharda Motor Industries Ltd. : 319 ITR 109 (Del- HC). • CIT vs. Munjal Showa Ltd. : 329 ITR 449 (Del)(HC). • CIT vs. Essel Propack 325 ITR 185 (Bom-HC). • CIT vs. Denso India P.Ltd. : ITA 16/2008 (Del)(HC). • CIT vs. DCM Ltd. : ITA No.87-89/1992 (Del)(HC). • CIT vs. JK Synthetics Ltd. : 309 ITR 371 (Delhi).
In the aforesaid judgments, the Courts have, on an analysis of the agreement, come to the conclusion that payment made under the agreement was deductible revenue expenditure, since there was no out and out/absolute transfer of the know-how by the owner-licensor to the assessee-licensee and the know-how supplied by the foreign company remained the property of the foreign company for all times to come; the assessee having only a limited right to use the know-how during the currency of the agreement.
In the case of assessee, no proprietary rights in the know how vested in the assessee, the assessee being a mere licensee with limited rights to use the technical assistance during the currency of the agreement. There is no explicit or implied intention to transfer or create ownership in the technical know-how/technical information in the assessee. On the contrary, it is unequivocally agreed that the know- how should at all times remain the property of Honda.
In view of the above, on a conjoint and cumulative reading of the various clauses of the agreement, taking into account the totality of circumstances, it will kindly be appreciated that the expenditure by way of royalty and technical guidance fee incurred by the assessee was allowable revenue deduction since - (i) payment was made for limited license to use the know-how provided by Honda, as the proprietary and ownership rights in the same continued to remain vested with Honda at all times and, there was, therefore, no absolute parting of know-how in favour of the assessee resulting in acquisition of any asset,
(ii) no benefit of enduring nature in the capital field accrued to the assessee (iii) The license to use the know- how was also non exclusive and Honda reserved the right to provide technology for manufacture of motorcycles to Honda Motorcycle and Scooters India Ltd. (iv) the subject 8 ITA-5130/Del/2010 payment made did not cover consideration paid for setting up of the manufacturing facility in India.
On the strength of the aforesaid decisions, the total expenditure on account of royalty and technical guidance fees was claimed as revenue expenditure.
The decisions of the Supreme Court in the case of Southern Switch Gear : 232 ITR 359 and Jonas Woodhead & Sons (India) Ltd. vs. CIT : 224 ITR 342 relied upon in the assessment order are not applicable to the facts of the case and are distinguishable.
Your Honour's attention is invited to the recent decision of Delhi High Court in the case of Sharda Motor Co. : 319 ITR 109, wherein it was held that royalty paid on the basis of rate per unit of production is revenue expenditure and cannot be considered as capital expenditure. The Delhi High Court in the aforesaid case distinguished the decision of Apex Court in the case of Southern Switch Gear (supra) on the ground that same was not applicable as in that case lumpsum payment was made, interalia, for setting up of factory and for that reason 25% thereof was treated as capital in nature.
In the case of assessee, too, the lumpsum payment, it is respectfully submitted has not been made towards setting up of the plant but the lumpsum payment as also the payment by way of royalty, made on the basis of rate per piece of sale of goods manufactured, is for use of technology licensed by Honda.
In view of the above, in light of ratio laid down by the aforesaid decision of Delhi High Court, too, the decision of Southern Switch Gear (supra) is not applicable upon the facts of the assessee's case and expenditure by way of royalty and technical guidance fee is allowable revenue expenditure in entirety.
d. Issue stands decided in assessee's favour in earlier years:
The expenditure on account of royalty, technical guidance fees was disallowed as capital expenditure for the first time for the assessment year 2000-01 and onwards, without
9 ITA-5130/Del/2010 there being any change in facts or new material coming to the knowledge of the department.
The aforesaid issue in the appeals for the assessment years 2000-01 to 2002-03 has been decided in favour of the assessee by the Tribunal vide order dated 16.04.2010 (refer Pages 1014-1088 of the Paper Book II).
In view of the above, on the ground of consistency as well, the impugned expenditure cannot be treated as capital in nature. In the following decisions the Courts have held that though the doctrine of res judicata does not strictly apply to the income-tax proceedings but in order to maintain consistency, the Revenue cannot be permitted to rake up settled issues:
• Radhasoami Satsang v. CIT : 193 ITR 321 (SC). • CIT vs. Neo Polypack (P) Ltd : 245 ITR 492 (Del.). • CIT V. A.K.J. Security Printers : 264 ITR 276 (Del). • DIT(E) vs. Apparel Export Promotion Council : 244 ITR 734 (Del.).
• Vesta Investment and Trading Co. (P) Limited v. CIT : 70 ITD 200 (Chd.).
6. The learned DR, on the other hand, relied upon the orders of the Assessing Officer as well as the DRP and has stated that since the assessee has an exclusive right for the manufacture and sale of motorcycles and even after the termination of the agreement the assessee was entitled to manufacture the motorcycles, therefore, the payment was certainly a capital expenditure. The Assessing Officer has already allowed the depreciation on such capital expenditure. He also submitted that the decision of the ITAT in the earlier year would not be applicable because law of res judicata is not applicable to the income tax proceedings. He also relied upon the following decisions in support of his claim that the payment of royalty is a capital expenditure :-
(i) Southern Switch Gear Ltd. Vs. CIT & Another - 232 ITR 359 (SC).
10 ITA-5130/Del/2010
(ii) Jonas Woodhead And Sons (India) Ltd. Vs. CIT - 224 ITR 342 (SC).
He, therefore, submitted that the order of the Assessing Officer is quite fair and reasonable and the same should be sustained.
7. We have carefully considered the arguments of both the sides and perused the material placed before us. We find that an identical issue was considered by the ITAT in assessee's own case for AY 2000- 01, 2001-02 & 2002-03 vide ITA Nos.716 & 717/Del/2008, 1312/Del/2008, 718/Del/2008, 1648/Del/2007 and 1623 & 1624/Del/2008. At page 2 of the order dated 16th April, 2010, the ITAT recorded the controversy in those appeals which is reproduced as under:-
"This is a group of appeals by the assessee and the Revenue, the main controversy pertains to issues about the capital or revenue nature of payment of royalty called Technical Guidance Fee (TGF) and model fee paid by the assessee M/s Hero Honda Motors Ltd. to Honda Motors, Japan. The same was allowed to the assessee as revenue expenditure in many assessment years. The department taking guidance from Hon'ble Supreme Court judgment in the case of Southern Switch Gear Ltd. 232 ITR 359, was of the view that payment of TGF and model fee was capital in nature. In furtherance of this view, department took up various actions in different assessment years like initiating proceedings u/s 263, reopening assessments u/s 147 etc. These appeals are result of this criss-cross of the claims of the assessee and department's action in this behalf."
8. At pages 2 to 72, the ITAT discussed at length the facts of the case, the agreement between the assessee and Honda Motor Co.Ltd., Japan, the various case law relied upon by both the sides and concluded its finding in paragraph No.7.18 onwards at pages 72 to 75.
11 ITA-5130/Del/2010 For the sake of brevity, we reproduce herein below the conclusion of the ITAT as under:-
"7.18. We have carefully considered the facts of assessee's case, SS's case, Jonas Woodhead and Sons (India) Ltd., Ciba of India Limited and other authorities relied before us. In our view, the assessee being in 15th year of its agreement which has peculiar facts, there being no IPR ownership available to assessee after termination, the exclusive licence granted to assessee after 10 years in 2nd agreement i.e. 1995 cannot be called an enduring benefit in the capital field, there is a difference between the long term capital benefit and enduring benefit for revenue generations. The assessee being in second round of agreement and 15th year of licence to manufacture, in our view, it will not be a totally comparable case with cases cited by the revenue which are short term agreements coupled with ownership of IPR and exclusive licence. The only similarity, which could be gathered in these cases, is existence of exclusive licence, which cannot be taken on standalone basis. Hon'ble Supreme Court has repeatedly underlined the need of considering all the facts of any agreement carefully. In our view, the only element of exclusive licence that too in the second agreement after 15 years duration cannot be divorced from all other attending facts and circumstances. Therefore, we are unable to subscribe the view of the revenue that any part of expenditure is attributable to any enduring benefit so as to make it capital expenditure.
7.19. Even if it is assumed that it has elements of enduring benefit the plea of Learned counsel about the same being revenue towards generating apparatus cannot be denied as by the so-called exclusivity what assessee can control is not the price of the know-how but the sale price of product in non- competitive Honda motorcycle market which will only increase the sale price and thus the revenue generating apparatus of assessee. In this eventuality also, the Supreme Court judgment of Empire Jute Co. Ltd. supports the assessee's case.
7.20. Here we may also add that assessee's plea about consistency on the basis of Hon'ble Supreme Court judgment
12 ITA-5130/Del/2010 in the case of Radhasoami Satsang (supra) is also relevant inasmuch as the Department has allowed the assessee expenditure in this behalf as revenue expenditure for a long period of 15 years. Hon'ble Supreme Court judgment in the case of SS and Jonas were pronounced in 1997 and with these judgments being on the case law books Department still allowed the assessee's expenditure in respect of TGF as revenue expenditure. In our view, the assessee's expenditure towards TGF/ model fee is fully eligible to be treated as revenue expenditure and even if it is assumed that there is any shred of doubt, the rule of consistency does help assessee's case and it will not be desirable that assessee be subjected to a new regime of opinion without analysis of peculiar facts. The model fee expenditure has already been settled by ITAT and Hon'ble Delhi High Court as revenue expenditure in assessee's own case. In view of all these facts, assessee succeeds on merits on the issue about Model Fee and TGF expenditure being fully allowable revenue expenditure.
7.21. Coming to the remaining grounds, assessee has not pressed issue about reopening of assessment u/s 148 hence the same are dismissed accordingly. Coming to order u/s 263, we have held that the above payments in assessee's case are revenue in nature and the view adopted by the Assessing Officer's in respective assessment years cannot be held to be erroneous, therefore, the 263 action is quashed. Learned counsel has made out clear case that in assessment year 2001-02, the 263 appeal before Hon'ble Delhi High Court was not pressed by the assessee and Hon'ble High Court passed the order to the effect that the issue will be open for consideration in other years. In our view, the view adopted by Assessing Officer allowing model fee and TGF expenses being a correct view, there was no error in passing original assessment order. Therefore, 263 action in assessment year 2002-03 is quashed. Since we have quashed the 263 order passed by CIT, subsequent proceedings i.e. AO's and CIT(A)'s consequential orders thereon order are also quashed.
7.22. Similarly, rectification order passed by CIT(A) in A.Y. 2000-01 is quashed as the issue of capital/ revenue was highly debatable and CIT(A) cannot revise his appellate order to disallow 25% of expenditure as capital expenditure u/s
154."
13 ITA-5130/Del/2010
9. Thus, in AY 2001-02, 2002-03 & 2003-04, the ITAT held the payment for royalty as well as model fee to be revenue expenditure and the disallowance made by the Assessing Officer at 25% of the total royalty payment was deleted. In AY 2003-04, 2004-05 & 2005-06, similar disallowances were made. It was explained by the assessee's counsel that the same are deleted by the learned CIT(A) and Revenue's appeal before the ITAT is pending. He, however, submitted that since it is a stay granted matter, the appeal should be disposed of without waiting for the disposal of the appeals for AY 2003-04, 2004-05 & 2005-06 because the issue is already settled by the ITAT in AY 2000- 01, 2001-02 & 2002-03. He also pointed out that the Revenue's appeals against the order of the ITAT for AY 2000-01, 2001-02 & 2002- 03 are pending before the Hon'ble High Court.
10. The learned DR, on the other hand, has no objection for disposal of this stay granted appeal despite the pendency of the appeals for AY 2003-04, 2004-05 & 2005-06.
11. Though the issue is covered by the decision of ITAT of earlier years (supra), however, we would like to deal with the merits of the case also for two reasons - (i) that, in the earlier years, the ITAT considered the agreement entered into on 2nd June 1995 while the agreement under consideration before us is the agreement dated 2nd June, 2004, and (ii) that, after the order of the ITAT, there are several decisions of the Hon'ble Jurisdictional High court on this issue.
12. We, therefore, discuss the merits of the case also. The Revenue has mainly relied upon the two decisions of the Hon'ble Apex Court, viz., Southern Switch Gear Ltd. (supra) and Jonas Woodhead And Sons (India) Ltd. (supra).
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13. In the case of Jonas Woodhead And Sons (India) Ltd. (supra), the facts were that the appellant, a limited company incorporated in March, 1963, to carry on the business of manufacture of automobile springs, entered into an agreement with an English company for manufacture of all types of springs and suspension for road and rail vehicles. Under the terms and conditions of the agreement between the parties, it was stipulated that the foreign company would give the appellant the technical information and know-how relating to the setting up of a plant suitable for manufacture of the products as well as the technical know-how relating to the setting up of the plant itself, the drawings, estimates, specifications, manufacturing methods, blueprints of production and testing equipment and other data and information necessary to manufacture the product and to set up proper and efficient plants. The agreement between the parties also provided that in consideration of the information to be furnished and services to be rendered to the appellant by the foreign company, the appellant shall pay a royalty at the rates of the licensed products turnover of the appellant to be calculated in accordance with the provisions of the agreement. The production of the appellant commenced on January 1, 1966, and in terms of the agreement the appellant made payments of Rs.24,000 and Rs.47,000, respectively, to the foreign company during the accounting period relevant to the assessment years 1967-68 and 1968-69, as royalty. In the assessment proceedings, the Income-tax Officer disallowed one-fourth of the payments on the ground that such payment represented the consideration for service provided by the foreign company of an enduring nature and was, therefore, capital expenditure. The Appellate Assistant Commissioner and the Tribunal confirmed the disallowance. On a reference, the High Court considered the various clauses of the agreement and held that the payment stipulated in clause 12 of the agreement was not remuneration for user of the rights granted by the foreign company but 15 ITA-5130/Del/2010 a composite payment for all the services rendered and information furnished by the said foreign company to the appellant in the setting up of the factory as well as in the manufacture of the licensed products in that factory. The High Court took the view that the appellant acquired a benefit of enduring nature and that the sum paid for the same would constitute capital expenditure. On appeal to the Hon'ble Supreme Court, it was held as under:-
"Held, affirming the decision of the High Court, that the High Court having considered the different clauses of the agreement and having come to the conclusion that under the agreement with the foreign company, what was set up by the appellant was a new business and the foreign company had not only furnished information and technical know-how but rendered valuable services in the setting up of the factory itself and even after the expiry of the agreement there was no embargo on the appellant to continue to manufacture the product in question, the entire payment made could not be held to be revenue expenditure, merely because the payment was required to be made at a certain percentage rate of the gross turnover of the products as royalty. The disallowance of 25 per cent of the sum paid as royalty by the appellant to the English company as capital expenditure, not allowable as revenue expenditure under the provisions of the Income-tax Act, 1961, for the assessment years 1967-68 and 1968-69, was correct."
14. In the case of Southern Switch Gear Ltd. (supra), the facts were that the assessee company entered into a collaboration agreement with a foreign company under the terms of which the foreign company agreed to provide the assessee-company technical aid and information in the manufacture of switchgears and the right to sell such products. The foreign company also agreed to keep the Indian company posted with the latest and modern developments in the field of manufacture of switchgears and transformers and to train the necessary personnel at its U.K. factory. Under the terms of the agreement, the assessee company agreed to pay to the foreign company as consideration for 16 ITA-5130/Del/2010 the services rendered by it, a royalty on sales and a lump sum for the technical aid, payable in five equal installments, the payment to be spread over a period of time. The Tribunal disallowed 25 per cent, of the technical fees and 25 per cent of the royalty paid by the assessee to the foreign company. The High Court held that a perusal of the various clauses of the agreement clearly indicated that the technical knowledge that the assessee obtained through the agreement with the foreign company secured to the assessee an enduring advantage and benefit in that the same was available to the assessee for its manufacturing and industrial process even after the termination of the agreement. The High Court held that the right to manufacture certain goods exclusively in India should be taken to be an independent right secured by the assessee from the foreign company which was of an enduring nature, that consequently, the entire technical fees could not be allowed as a revenue expenditure, and that the Tribunal was, therefore, right in its view that 25% of the technical aid fees would have to be taken as being capital in nature. Since the foreign company had also agreed not to manufacture in India any of the products in question or grant or make available to any other person any information relating to manufacture, license, or rights, for any of the products in question in India thereby conferring on the assessee exclusive right of manufacture and the sale of the products, the High Court held that the clause in the agreement indicated that the assessee paid the royalty for the acquisition of an exclusive privilege of manufacturing and selling the products and the acquisition of such a right was rightly treated by the Tribunal as partly towards capital and partly towards revenue. The High Court affirmed the disallowance of royalty estimated at 25 per cent by the Tribunal. On appeal to the Hon'ble Supreme Court, the Apex Court affirmed the judgment of the Hon'ble High Court as under:-
17 ITA-5130/Del/2010 "We have perused the order of the High Court. We have also seen the agreement. We are not persuaded to hold that the view taken by the High Court is erroneous; the appeals are dismissed. There will be no order as to costs."
15. The learned counsel for the assessee has relied upon a large number of decisions but, for the sake of brevity, we are discussing herein below only the decisions of Hon'ble Jurisdictional High Court and, that too, delivered after the above two decisions of the Hon'ble Apex Court.
16. In the case of CIT Vs. Lumax Industries Ltd. - 173 Taxman 390 (Delhi), the assessee company entered into an agreement with M/s Stanley Electric Co.Ltd. (SECL) on year to year basis for acquisition of technical knowledge. The assessee claimed the said payment as revenue expenditure. The Assessing Officer disallowed the claim holding that by virtue of the agreement, the assessee had derived an asset of enduring nature. On appeal, the CIT(A) allowed the assessee's claim holding that the expenditure incurred by the assessee was a recurring expenditure and not a capital expenditure. The Tribunal upheld the order of the CIT(A). On Revenue's appeal to the High Court, it was held as under:-
"A perusal of the Circular No.21 of 1969, dated 9-7-1969 shows that if in terms of the agreement, only a licence is required for user of technical knowledge from a foreign participant for a limited period together with or without the right to use the patents and trade marks of the foreign party, the payment would not bring into existence an asset of an enduring advantage to the Indian party. Relying upon this circular, the Commissioner (Appeals) concluded that the assessee had been paying the licence fee to 'S' on a year-to-year basis for acquisition of technical knowledge, and even if the assessee acquired a set-up of an enduring nature, it would not amount to a capital expenditure but to a revenue expenditure.
18 ITA-5130/Del/2010 The Commissioner (Appeals) also noted that from the financial year 1985-86 till 1993-94, the assessee had been paying the license fee every year and for each of those years it had been incurring expenses claimed as revenue expenditure and that was being allowed by the Assessing Officer. Therefore, there was no reason as to why after a gap of almost 10 years, the Assessing Officer should suddenly change his mind and decide to treat the expenditure incurred by the assessee as a capital expenditure.
The Tribunal added that even if the assessee had obtained a long term advantage of an enduring advantage, that, by itself, would not covert any expenditure incurred by it into a capital expenditure.
In the instant case, the facts had been fully considered and a concurrent opinion had been expressed, both by the Commissioner (Appeals) as well as by the Tribunal that the expenditure was of a revenue nature and not of a capital nature.
There was no reason to differ with the opinion on the facts of the instant case and it was quite clear that the ratio of the decisions of the Supreme Court in Jonas Woodhead & Sons ((India) Ltd. v. CIT [1997] 224 ITR 342/91 Taxman 1 and in Empire Jute Co.Ltd. v. CIT [1980] 124 ITR 1/3 Taxman 69 was fully applicable to the facts of the instant case and both the authorities were right in concluding that the payment made by the assessee towards licence fee to 'S' was a revenue expenditure."
17. In the case of Shriram Pistons & Rings Ltd. Vs. CIT, New Delhi - [2008] 171 Taxman 81 (Delhi), the facts of the case are that the assessee company had entered into a technical collaboration agreement with a Japanese company, 'R' for the manufacture of piston rings. The said agreement mentioned that the technical know-how would be sold by 'R' to the assessee for a fixed amount and the payments would be made on the fulfillment of certain conditions. The agreement enabled the assessee to sub-license the technical know- how to another Indian party subject to the prior written permission of 19 ITA-5130/Del/2010 'R'. The validity of the agreement was for a period of five years, but it could be terminated before the expiry of that period in the event of any default by any of the parties. The agreement laid down that the right of the assessee to market any of the products manufactured under the agreement would cease upon its expiry or termination. Pursuant to the said agreement, the assessee paid certain amount to 'R' and claimed same as revenue expenditure. The lower authorities, relying on the word 'sold' in the agreement, held that it was a case of sale of technical know-how by 'R' to the assessee and, therefore, payment in question could not be treated as revenue expenditure. However, the Tribunal held that there was no sale of technical know- how by 'R' to the assessee and, therefore, the payment was revenue expenditure. It was held as under:-
"There was, in fact, no absolute transfer of any right in the documentation given by 'R' to the assessee. The assessee was entitled to use the technical know-how for a period of five years or for a lesser period, in case the agreement was terminated before that. The assessee did not have a free hand to sub-license the technical know-how and that was possible only with the prior written permission from 'R'. For all other matters, the assessee was liable to treat as confidential all inventions, drawings, documents, specifications, etc., furnished by 'R' to it. Even though the assessee was entitled to use the name of 'R' in the marketing of its products, yet that right would cease upon the expiry or termination of the agreement.
The agreement was valid only for a period of five years, but could be terminated earlier. There was no magic in the word 'sold' used in clause 5.0 of the agreement because on a reading of the agreement as a whole, it appeared that what was transferred to the assessee was only a right to use the technical know-how of 'R' and there was no sale of the technical know-how which the assessee could exploit. The assessee's rights were hedged in with all sorts of conditions, clearly making it a case of right to use the technology and not sale of the technical know-how.
20 ITA-5130/Del/2010 Therefore, the Tribunal was justified in holding that there was no sale of technical know-how by 'R' to the assessee and, hence, the payment made by the assessee to 'R' was a revenue expenditure."
18. In the case of CIT Vs. Sharda Motor Industrial Ltd. - [2009] 319 ITR 109 (Delhi), the facts are that the assessee had entered into two agreements with a Korean company under which the assessee was to pay a lump sum amount for transfer of technical know-how and running royalty at a specified rate per "piece of production" of different products. The assessee showed the lump sum payment against transfer of technical know-how provided by the Korean company as capital expenditure and claimed that the royalty was business expenditure. The Assessing Officer treated the royalty as capital expenditure. The order of the Assessing Officer was reversed by the Commissioner (Appeals) and this was affirmed by the Appellate Tribunal. On appeal, it was held as under:-
"That the finding of the Commissioner (Appeals) that the payment of royalty was purely a revenue expenditure, which was annual expenditure depending upon the quantum of production in the relevant year was a finding of fact rightly arrived at."
19. In this case, their Lordships discussed the earlier decision of Hon'ble Jurisdictional High Court in the case of CIT Vs. J.K.Synthetics Limited - [2009] 309 ITR 371 (Delhi) wherein their Lordships have enumerated certain principles for determining whether the payment of royalty is a capital expenditure or revenue expenditure. The same is discussed at pages 111 & 112 of 319 ITR and is being reproduced herein below for ready reference:-
"(v) expenditure incurred for grant of licence which accords 'access' to technical knowledge, as against, 'absolute' transfer of technical knowledge and information 21 ITA-5130/Del/2010 would ordinarily be treated as revenue expenditure. In order to sift, in a manner of speaking, the grain from the chaff, one would have to closely look at the attendant circumstances, such as :
(a) the tenure of the licence,
(b) the right, if any, in the licensee to create further rights in favour of Tribunal third parties,
(c) the prohibition, if any, in parting with a confidential information received under the licence to third parties without the consent of the licensor,
(d) whether the licence transfers the 'fruits of research' of the licensor, 'once for all',
(e) whether on expiry of the licence the licensee is required to return back the plans and designs obtained under the licence to the licensor even though the licencee may continue to manufacture the product, in respect of which 'access' to knowledge was obtained during the subsistence of the licence.
(f) whether any secret or process of manufacture was sold by the licensor to the licensee. Expenditure on obtaining access to such secret process would ordinarily be construed as capital in nature;"
In the present case, on facts, it was, inter alia, found as follows:
"(a) in that case the grant of technical aid was for setting up of the factory combined with the right to sell products while in our case our company is already producing exhaust systems and the technology agreement was not for setting up of the factory.
(b) in the cited case the foreign company who gave the technology agreed not to manufacture similar products in India while there is no such regulation in our agreement.
(c) in the cited case the technical knowledge obtained was held to give an advantage of enduring nature to the assessee-company and as it had the right to continue to manufacture the product even after termination of the 22 ITA-5130/Del/2010 agreement. While in our case the design patent applies to the foreign company and we are only licensed to produce the goods for Hyundai Car and we cannot continue to produce the goods if the agreement is terminated. This itself is a major difference between the case cited by your honour and the facts of our case."
On the facts and after applying the aforesaid principle, it becomes crystal clear that the expenditure is of revenue nature."
20. In the case of Climate Systems India Ltd. Vs. CIT - [2009] 319 ITR 113 (Delhi), the facts of the case are that the assessee company engaged in the manufacture and sale of heat exchangers (radiators) entered into technical collaboration agreement with a US company to manufacture radiators with technology owned by the US company. Under the agreement, the assessee was permitted to use the technology for manufacture of upgraded radiators for which the assessee was to make a lump sum payment of US $ 1 million to the US company, which was capitalized in the assessee's books of account and a royalty of 3 per cent. of domestic sales and 5 per cent. of export sales to the US company for a period of 7 years for using the technology and for availing of technical services. During the previous year relevant to the assessment year 2002-03, the assessee paid to the foreign collaborators royalty calculated at 3 per cent. of domestic sales and at 5 per cent. of export sales and claimed deduction thereof as business expenditure. The Assessing Officer disallowed it as being of capital nature and this was confirmed by the Commissioner (Appeals) as did the ITAT on the grounds, inter alia, (a) that even after termination of the agreement the assessee could continue to use technical information in production of licensed products and hence the assessee obtained enduring benefit, and (b) that there was nothing to show that any technical service was to be provided on day-to-day or on regular basis at any specified interval and thus it was a case of outright 23 ITA-5130/Del/2010 transfer of technical know-how. On appeal, the Hon'ble Jurisdictional High Court held as under:-
"Held, allowing the appeal, that under the agreement, payments were to be made by the assessee in two parts :
a lump sum fee for transfer of technology (which the assessee had admitted as being of capital nature) and royalty payment in consideration of providing technology services. The payment of royalty depended on the quantum of domestic as well as export sales which would decrease or increase every year depending upon the decrease or increase in the sales. This payment was not because of "transfer" of technology, but for providing "technical services". In such circumstance, the payment of royalty, which was a continuous process, should have been treated as revenue expenditure."
21. In the case of CIT Vs. Munjal Showa Ltd. - [2010] 329 ITR 449 (Delhi), the facts of the case are that the assessee was engaged in the business of manufacture of shock absorbers used in automobile vehicles under license from S, a Japanese company. It incurred expenses on travel and stay of foreign technical personnel of S in Japan and also on designs and drawings charges payable to S. The assessee claimed the entire expenses as revenue expenditure. The Assessing Officer treated the expenses as capital expenditure which was confirmed by the CIT(A). The Tribunal held that the expenses were incurred for training the personnel of the assessee and for availing of drawings and designs to manufacture the shock absorbers but not for acquiring technology itself and, therefore, they could not be held to capital expenditure. On appeal, their Lordships of Jurisdictional High Court held as under:-
"Held, dismissing the appeals, that the know-how was granted by the foreign company solely for the purpose of manufacture, assembly and sale of products during the term of the contract and the license was to pay royalty to the licensor. The drawings and designs which were 24 ITA-5130/Del/2010 supplied by the licensor only enabled the assessee to manufacture the shock absorbers. The assessee was required to change the design of such shock absorbers from time to time for which new drawings and designs were required. For this purpose, the training of the personnel of the assessee was imperative. Under the agreement, the know-how acquired related to the process of manufacturing and for a technical and the documents, designs and specifications which had been supplied by the licensor were only for facilitating this purpose of manufacturing. This was basically in the realm of technical support."
22. Now, we come to the assessee's case so as to reach to the conclusion as to which of the above decisions would be applicable. At the outset, we may mention that the Assessing Officer has heavily relied upon the decisions of the Hon'ble Apex Court in the case of Southern Switch Gear Ltd. (supra) and Jonas Woodhead And Sons (India) Ltd. (supra), for holding that the payment of royalty is capital expenditure. But, the Assessing Officer has not fully applied those decisions because in both the cases, only 25% of the royalty payment was held to be capital expenditure and 75% was allowed as revenue expenditure. Though the Assessing Officer has relied upon those decisions, but he disallowed the entire payment as capital expenditure. Be that as it may, let us look to the facts of the assessee's case. The assessee had set up its plant in the year 1984 to manufacture motorcycles by using know-how of Honda Motor Co.Ltd. ('HMCL') through technical collaboration contract dated 24th January, 1984. Under the agreement, the assessee was provided technical assistance for manufacture, assembly and service of the product and was also provided with information, drawings and designs for setting up of the plant. The assessee was required to pay lump sum amount of $5,00,000 in consideration of technical information for setting up of plant which was capitalized in the books of account and no part thereof was claimed as revenue expenditure. In addition to the above, the 25 ITA-5130/Del/2010 assessee was required to pay certain percentage of sale consideration as royalty year after year. Till AY 1999-2000, i.e. almost for 15 years, the yearly payment of royalty claimed as a revenue expenditure was allowed by the Department. It was for the first time that the dispute arose in AY 2000-01 and then in AY 2000-01, 2001-02 & 2002-03, and the ITAT accepted the assessee's claim which has been discussed by us in detail in the earlier part of our order. In AY 2003-04, 2004-05 & 2005-06, the claim is disallowed by the Assessing Officer but it is stated by the learned counsel that it has been allowed by the learned CIT(A). However, in this year, the Assessing Officer disallowed 100% royalty holding it to be capital expenditure and the same is also sustained by the DRP. Hence, this appeal by the assessee.
23. In the year under consideration, the payment of royalty is as per agreement dated 2nd June, 2004. The preamble of the agreement reads as under:-
"Preamble LICENSOR and LICENSEE entered into (i) a Technical Collaboration Contract dated January 24, 1984 ("1984 TC Contract"), a successively to the expiration of 1984 TC Contract, (ii) a License and Technical Assistance Agreement dated June 2, 1995 ("1995 LTAA") which was taken on record by the Government of India on 22nd of August, 1995, under which LICENSEE was entitled, among other things, a right and license in manufacture, assemble, sell, distribute, repair and service certain two/three wheelers and parts thereof as defined therein, designed and developed by LICENSOR.
LICENSOR and LICENSEE mutually desire that the licensing arrangement under 1995 LTAA be extended for an additional period in accordance with the terms and conditions, set forth hereinafter, which will henceforth govern their relationship."
26 ITA-5130/Del/2010
24. Thus, the agreement dated 2nd June, 2004 is virtually an extension of the agreement dated 2nd June, 1995 considered by the ITAT in its order for AY 2000-01, 2001-02 & 2002-03 (supra). The important clauses of the agreement read as under:-
"Article Article 2 (Grant of License and Exclusivity) Subject to the terms and conditions herein contained, LICENSOR hereby grants to LICENSEE an indivisible, non- transferable and exclusive right and license, without the right to grant sublicenses, to manufacture, assemble, sell and distribute the Products and the Parts during the term of this Agreement within the Territory under the Intellectual Property Rights and by using the Technical Information. Provided, it is acknowledged by LICENSEE, (i) the exclusivity granted herein is against the third parties but not HMSI, and (ii) the exclusivity against HMSI is only with respect to the exterior of the Products.
It is agreed between the parties that subject to the terms hereof, the LICENSOR shall make necessary endeavours so that New Model(s) for the LICENSEE are introduced in a phased and timely manner in order to meet the request from the LICENSEE and such introduction would be on reasonable criteria."
"Article Article 17 (Maintenance of Secrecy) 17.1 The Know-How, Technical Information and any other non-public technical or business information of LICENSOR (such information being collectively hereinafter referred to as the "Information") shall remain the sole and exclusive property of LICENSOR and shall be held in trust and confidence for LICENSOR by LICENSEE, inter alia, in accordance with this Article 17.
17.2 LICENSEE agrees that it shall not, either during the term of this Agreement or thereafter, make known, divulge or communicate any Information in any way or manner whatsoever to any person, legal person or any other entity except otherwise provided herein.
17.3 LICENSEE further agrees that it shall take all necessary precautions to keep the information secret and 27 ITA-5130/Del/2010 confidential, and to restrict its use as provided for in the 1984 TC Contract and 1995 LTAA or in Article 18 hereof, as the case may be, and, for that purpose, shall establish and maintain internal regulations and procedures for protection of the secrecy, as approved by LICENSOR, recognizing that LICENSEE shall use at least the same degree of precautions as it takes to protect its own confidential information, and all reproduced copies shall be numbered in numerical sequence and such reproduced copies shall also remain the property of LICENSOR."
"Article Prohi Article 18 (Limitation of Use, and Other Prohibition) hibition) 18.1 LICENSEE shall not use or cause or permit to be used by any third party the Intellectual Property Rights and the Technical Information licensed or provided hereunder, and the Licensed Parts manufactured by LICENSEE and/or its Subcontractors hereunder and the Supply Parts supplied to LICENSEE and/or its purchasing agencies designated by LICENSEE hereunder, in the manufacture, assembly, servicing, sale or other disposition of any goods other than the Products, or for any purpose other than as expressly provided in this Agreement.
18.2 LICENSEE shall neither file nor cause to be filed in any country any patent or other intellectual property right application which incorporates or is directed to the Intellectual Property Rights, the Technical Information, the Know-How or the Trademarks disclosed to LICENSEE hereunder. If LICENSEE, in violation of this Article 18.2, files any application for any patent or other intellectual property rights in any country, it shall be deemed a breach of this Agreement, and further, the right to such application and any intellectual property rights resulting from such application shall be automatically gratuitously assigned and transferred by LICENSEE to LICENSOR.
18.3 In the event any inventions and improvements which relate to the Products, the Parts, the Know-How or the Intellectual Property Rights was made by LICENSEE or its directors, officers, employees and Subcontractors in the course of or as the result of the change as set forth in Article 19.3 hereof, LICENSEE shall promptly disclose in writing to LICENSOR all such inventions and improvements, and LICENSEE, insofar as lawfully may, hereby grants or causes to be granted to LICENSOR a transferable right and 28 ITA-5130/Del/2010 license to use such inventions and improvements in any country with right to sublicense. The terms of any sublicense with respect to patented inventions or improvements shall be approved by LICENSEE prior to the granting of such sublicense. Upon request by LICENSOR, LICENSOR and LICENSEE shall jointly file applications for appropriate patent or other statutory intellectual property rights with respect to such inventions or improvements in any country. The right and license granted to LICENSOR hereunder shall be royalty-free during the term of this Agreement and shall, after any termination or expiration of this Agreement, continue for such period and on such terms as may be mutually agreed upon.
18.4 LICENSEE shall claim no title or property right whatsoever during the existence of this Agreement and if this Agreement is terminated as a result of the default of LICENSEE, then LICENSEE shall claim no right, title, property, interest or use whatsoever at all times after the life of this Agreement as regards the Intellectual property rights, Know-how, Technical Information or other Information received under this Agreement."
"Article Article 25 (Consideration)
25.1 In consideration of the right and license granted to LICENSEE under Article 2 hereof and of the furnishing of the Technical Information hereof, LICENSEE shall pay to LICENSOR the following model fee and running royalty:
(1) Model Fee - .................................(2)
(2) Running Royalty LICENSEE shall pay the running royalty to LICENSOR during the Royalty-Period on any and all Products carried out of the manufacturing facility of LICENSEE for delivery to any and all purchasers, renters or other transferees whether in the Territory or not. Such running royalty shall be (a) the amount specified in Exhibit I attached hereto or (b) the amount calculated by multiplying by the rate specified in Exhibit I attached hereto or (b) the amount calculated by multiplying by the rate specified in Exhibit I attached hereto (including any revision thereof) with the ex-factory sales price (or ex-warehouse sales price in case of the Products kept in a warehouse immediately before such 29 ITA-5130/Del/2010 delivery) of such Products invoiced by LICENSEE to purchaser, renters or other transferees of such Products, less, in case of (b) herein:
(i) the landed cost (including ocean freights, insurance premiums, customs duties and other inland expenses) or the Supply Parts irrespective of source of import;
(ii) the cost to LICENSEE of the standard bought-out component parts listed in Exhibit IV attached hereto; and
(iii) excise duties imposed on LICENSEE by the Government of India and included in said ex-factory sales price or ex-warehouse sales price.
It being understood by the parties that the aforesaid deduction in respect of calculation of running royalties shall be in accordance with the prevailing policy of the Government of India."
"Article Article 33 Effect of Expiry and Termination 33.1 In the event of any termination pursuant to Article 32.1 on account of material breach by LICENSOR of its obligations under this Agreement, and subject to the due performance by LICENSEE of its material obligations, LICENSEE may continue to manufacture, assemble, sell, deliver and service the Products and the Parts until the due expiration date of this Agreement as specified in Article 31.
33.2 In the event of any termination pursuant to Article 32.1 on account of material breach by LICENSEE of its material obligations under this Agreement, LICENSEE shall discontinue (i) the manufacture, sale and other disposition of the Products and the Parts, and (ii) the use of the Intellectual Property Right and the Technical Information licensed or furnished by LICENSOR under this Agreement without incurring any obligation of LICENSOR to agree to LICENSEE's continuation of the grant of the right and license provided hereunder.
33. Notwithstanding anything to the contrary contained in this Agreement, in the event this Agreement expires on its own terms : LICENSOR and LICENSEE agree as follows:
30 ITA-5130/Del/2010 33.3.1 Subject to the provision of Article 33.3.2 herein below, the LICENSEE shall continue manufacture, sale, distribution and service of the Product(s) and the Part(s) and the right to use the Technical Information in respect of the manufacture, sale, distribution and service of Product(s) and the Part(s).
33.3.2 The continued right of use by LICENSEE as envisaged under Article 33.3.1 above is inter alia upon the following mutual understanding:
(i) LICENSEE shall pay the LICENSOR
(a) any outstanding amount under the applicable Model Agreement to LICENSOR as on the date of expiry or termination of this Agreement towards the cost of right of use by LICENSEE of Technical Information for the manufacture, sale, distribution and disposition of Products;
and
(b) the relevant consideration for a term of three years from the date of expiry/termination, which shall be half of the current royalty rate(s) as specified under this Agreement;
(ii) For the avoidance of any doubt, LICENSEE shall not make any further payment beyond the period mentioned in 33.3.2(i)(b) above in respect of such continued right to manufacture, sale, distribution and service of the Product(s) and Part(s) as envisaged in Article 33.1.1 above.
33.4 LICENSEE shall promptly discontinue the use of the Trademarks licensed by LICENSOR hereunder and shall not claim any right, title and interest whatsoever in the said Trademarks.
33.5 The expiration or any other termination of this Agreement hereunder shall be without prejudice to any right which shall have accrued to either party hereunder prior to such expiration or termination.
33.6 LICENSEE shall, to the extent it is reasonable and feasible, return to LICENSOR all particular documents and tangible property supplied by LICENSOR in connection with this Agreement and belonging to LICENSOR and all copies and translations thereof except in the event of termination 31 ITA-5130/Del/2010 in accordance with Article 33.1, and shall keep all information received by LICENSEE hereunder secret and confidential in accordance with Article 17 hereof.
33.7 LICENSEE shall not be entitled to demand from LICENSOR, for the reason of the expiration or termination of this Agreement or the failure to renew or extend it, any damages, reimbursements or other payments on account of the current or prospective profits on LICENSEE's sale or anticipated sale of the Products and the Parts, or on account of LICENSEE's expenditures, investments or commitments made in connection with the manufacture of the Products and the Parts, or on account of the establishment, development or maintenance of the goodwill or other business of LICENSOR, or on account of any other cause or thing whatsoever, except in case where this Agreement is terminated for any reason directly imputable to LICENSOR.
33.8 The LICENSEE shall promptly discontinue the use of;
(i) the Trademarks licensed by LICENSOR hereunder and shall not claim any right, title and interest whatsoever in the said Trademarks. Further, LICENSEE agrees to terminate the utilization or the product names, product code or product identifications used for the Products under this Agreement and 1995 LTAA which being ; (i) introduced by LICENSOR, (ii) or originated from any of other LICENSOR's Products names, code or identifications and, regardless of their registration status or ownership of such names, code or identifications. For the avoidance of doubt, the names of the Products introduced by LICENSOR or originated from LICENSOR's products names, code or identifications shall include, without limitations; "CB", "CBZ", "CD" and "CD100". For the purposes of this Article 33.8, LICENSEE's obligations to discontinue under para (i) and (ii) above shall not include, without limitations "AMBITION", "AMBITION 135", "DAWN", SPLENDOR", "SPLENDOR+", "PASSION", "PASSION PLUS", "JOY", "SLEEK", "STREET SMART" AND "KARIZMA"."
(emphasis by underlining supplied by us)
25. From the reading of the agreement, it is evident that various clauses of the agreement do not support the finding of the Assessing Officer. The inference of the Assessing Officer is that the payment 32 ITA-5130/Del/2010 under this agreement is for acquisition of technical know-how and technical information for manufacturing of two wheelers and, therefore, he held the payment to be capital in nature for acquisition of intangible asset and allowed depreciation at the rate of 25% thereon. While arriving at the conclusion, he has observed that the assessee has an exclusive right of manufacture, sale and distribution. However, from Article 2 of the agreement, it is evident that the exclusive right is only against the third parties and not against HMSI. Article 17 of the agreement clearly provides that the know-how, technical information and any other business information of licensor shall remain the sole and exclusive property of the licensor and shall be held in trust and confidence by the licensee. Article 18 of the agreement provides that the licensee (i.e. the assessee) shall not permit any third party to use the intellectual property right or the technical information provided under this license. Paragraph 18.3 of the agreement provides that even in respect of any inventions and improvements made by the licensee i.e. the assessee, the licensee is required to disclose it to the licensor i.e. HMSI and it is the HMSI who will have a transferable right to use such inventions and improvements with right to sub-license. Therefore, not only the original information and know-how provided by the licensor is the property of the licensor and not the assessee but even any inventions and improvements made by the assessee would be transferred to the licensor by the licensee. Paragraph 18.4 clearly provides that the assessee shall not claim any title or property right in respect of any intellectual property rights, know-how, technical information etc. provided under this agreement. Article 25 provides the consideration to be paid by the assessee for the use of technical information provided to the assessee under this license. The consideration is in the form of model fee as well as the running royalty. Paragraph 33.6 of the agreement provides that the licensee i.e. the assessee shall return to the licensor all documents and tangible 33 ITA-5130/Del/2010 property supplied by licensor in connection with this agreement. This proves beyond doubt that the intangible property continues to be owned of the licensor and the assessee has not acquired any know- how or license by virtue of this agreement which can be said to be intangible asset of the assessee.
26. In the light of these facts, let us examine the various decisions discussed above so as to arrive at the finding which of the decisions is applicable in the case of the assessee.
27. In our opinion, the facts of the assessee's case are identical to the facts in the case of Climate Systems India Ltd. (supra). In the case of Climate Systems India Ltd. (supra), the assessee company made the lump sum payment and also the running royalty. The running royalty was calculated as a percentage of sales. The lump sum payment was treated as capital expenditure by the assessee company and the running royalty was treated as revenue expenditure. The Assessing Officer disallowed the running royalty holding it to be capital expenditure which was confirmed by the learned CIT(A) as well as the ITAT. The Hon'ble Jurisdictional High Court allowed the appeal. The facts of the assessee's case are identical because the assessee also in the year 1984 entered into an agreement by which the assessee was provided with technical assistance for setting up of the plant and also for manufacture, assembly and service of the motorcycles. The assessee made lump sum payment of $5,00,000 for the technical assistance for construction of plant and paid a running royalty as a percentage of sales in respect of technical assistance for manufacture, assembly and service of the motorcycles. The running royalty which was paid annually was claimed as revenue expenditure and was disallowed by the Assessing Officer treating the same as capital expenditure. Thus, the facts of the assessee's case are identical to the 34 ITA-5130/Del/2010 facts before the Hon'ble Jurisdictional High Court in the case of Climate Systems India Ltd. (supra).
28. Similar were the facts before the Hon'ble Jurisdictional High Court in the case of Sharda Motor Industrial Ltd. (supra). In that case also, SMIL made a lump sum payment and also running royalty at a specified percentage based upon the production. The lump sum payment was treated as capital expenditure and running royalty was claimed as revenue expenditure. The Assessing Officer treated the royalty as capital expenditure and the Hon'ble Jurisdictional High Court affirmed the views of the Tribunal that the payment of running royalty was revenue expenditure. In this case, the Hon'ble Jurisdictional High Court has considered the decision of Hon'ble Apex Court in the case of Southern Switchgears Ltd. (supra) relied upon by the Revenue.
29. In the case of Lumax Industries Ltd. (supra), the assessee was paying license fee on year to year basis for acquisition of technical knowledge. The LIL claimed the said payment as revenue expenditure which was disallowed by the Assessing Officer holding that by virtue of the agreement, the LIL had derived an asset of enduring nature. On appeal, the CIT(A) allowed the assessee's claim and the Tribunal upheld the order of the CIT(A). On further appeal, the Hon'ble Jurisdictional High court upheld the order of the ITAT and has also observed that even if the assessee had obtained the long term advantage of enduring benefit, that by itself would not convert any expenditure incurred by the assessee into capital expenditure. This decision of Hon'ble Jurisdictional High Court is after considering the decision of Hon'ble Apex Court in the case of Jonas Woodhead and Sons (India) Ltd. (supra) relied upon by the Revenue. The decisions of Hon'ble Apex Court in the case of Southern Switch Gear Ltd. (supra) and Jonas Woodhead And Sons (India) Ltd. (supra) have slightly 35 ITA-5130/Del/2010 different facts because in both the cases, there was a collaboration agreement by which technical assistance was provided for setting up of the factory and also manufacture and sale of product. The payment of royalty was lump sum payment and, therefore, the Hon'ble Apex Court upheld the view of the Revenue that 25% of the payment is capital in nature. In the case of the assessee also, the collaboration agreement was for grant of technical assistance for setting up of the factory and also for the manufacture and sale of the product. But the assessee made separate payment for the technical assistance for setting up of the factory which was $5,00,000. This sum was treated as capital expenditure by the assessee itself. The annual payment for the royalty was based upon the percentage of sale of the motorcycles. Thus, the facts in the case of the assessee are distinguishable than the facts before the Hon'ble Apex Court. On the other hand, the facts of the assessee's case are identical to the facts before the Hon'ble Jurisdictional High Court in the case of Climate Systems India Ltd. (supra) and Sharda Motor Industrial Ltd. (supra) and also the decision of ITAT in assessee's own case cited supra. We, therefore, respectfully following the above decisions of Hon'ble Jurisdictional High Court, hold that the annual payment of royalty was a revenue expenditure. Accordingly, ground No.6 of the assessee's appeal is allowed.
30. Ground Nos.7, 7.1 & 7.2 of the assessee's appeal read as under:-
"7. That the assessing officer erred on facts and in law in computing disallowance under section 14A of the Act at Rs.128.29 lacs as against amount of Rs.15.08 lacs suomoto disallowed by the appellant in the return of income.
7.1 That the assessing officer erred on facts and in law in computing disallowance under section 14A of the Act in terms of Rule 8D of the Income Tax Rules, 1962 ('the Rules'), without appreciating that the said rule was not applicable during the relevant previous year.
36 ITA-5130/Del/2010 7.2 That the assessing officer erred on facts and in law in applying provisions of Rule 8D in a routine manner, without recording any finding/satisfaction as to why the disallowance under section 14A of the Act made by the appellant in the return of income, was not correct."
31. At the time of hearing before us, it is submitted by the learned counsel that in the return of income, the assessee has suo motu disallowed a sum of `15.08 lacs under Section 14A. That the Assessing Officer computed the disallowance under Section 14A as per Rule 8D of the Income-tax Rules, 1962 and worked out the disallowance at `128.29 lacs as against `15.08 lacs offered by the assessee. The DRP sustained the order of the CIT(A).
32. It is submitted by the learned counsel that the assessment year under consideration is 2006-07 while Rule 8D of the Income-tax Rules has come into existence with effect from AY 2008-09. That the Hon'ble Bombay High Court in the case of Godrej and Boyce Mfg. Co.Ltd. Vs. DCIT and Another - [2010] 328 ITR 81 (Bom) and also the Hon'ble Jurisdictional High Court in the case of Maxopp Investment Ltd. Vs. CIT, New Delhi - [2011] 203 Taxman 364 have held that Rule 8D is not retrospective and, therefore, not applicable in the assessment years prior to AY 2008-09. He, therefore, submitted that the working of disallowance under Section 14A by the Assessing Officer as per Rule 8D is not justified. He also submitted that since the assessee itself has disallowed the expenditure to the extent of `15.08 lacs, no further disallowance would be made.
33. The learned DR, on the other hand, stated that in the case of Maxopp Investment Ltd. (supra), the Hon'ble Jurisdictional High Court has set aside the matter to the file of the Assessing Officer for recomputing the disallowance. He, therefore, submitted that following 37 ITA-5130/Del/2010 the above decision of Hon'ble Jurisdictional High Court, this issue should be set aside to the file of the Assessing Officer.
34. We have considered the arguments of both the sides and perused the material placed before us. We find that an identical issue is considered by the Hon'ble Jurisdictional High Court in the case of Maxopp Investment Ltd. (supra) wherein their Lordships held as under:-
"So, even for the pre rule 8D period, whenever the issue of section 14A arises before an Assessing Officer, he has, first of all, to ascertain the correctness of the claim of the assessee in respect of the expenditure incurred in relation to income which does not form part of the total income under the Act. Even where the assessee claims that no expenditure has been incurred in relation to income which does not form part of total income, the Assessing Officer will have to verify the correctness of such claim. In case, the Assessing Officer is satisfied with the claim of the assessee with regard to the expenditure or no expenditure, as the case may be, the Assessing Officer is to accept the claim of the assessee insofar as the quantum of disallowance under section 14A is concerned. In such eventuality, the Assessing Officer cannot embark upon a determination of the amount of expenditure for the purposes of section 14A(1). In case, the Assessing Officer is not, on the basis of objective criteria and after giving the assessee a reasonable opportunity, satisfied with the correctness of the claim of the assessee, he shall have to reject the claim and state the reasons for doing so. Having done so, the Assessing Officer will have to determine the amount of expenditure incurred in relation to income which does not form part of the total income under the said Act. He is required to do so on the basis of a reasonable and acceptable method of apportionment."
35. In the case of the assessee, the Assessing Officer has worked out the disallowance under Section 14A as per Rule 8D. As per the decision of Hon'ble Bombay High Court in the case of Godrej and Boyce Mfg. Co.Ltd. (supra) and also the Hon'ble Jurisdictional High Court in 38 ITA-5130/Del/2010 the case of Maxopp Investment Ltd. (supra), Rule 8D cannot be applied in assessment year 2008-09. Therefore, the disallowance was to be computed as per the observation of the Hon'ble Jurisdictional High Court in the case of Maxopp Investment Ltd. (supra). We, therefore, set aside the orders of the authorities below on this point and restore the matter to the file of the Assessing Officer with the direction that he shall rework the disallowance under Section 14A as per the observation of the Hon'ble Jurisdictional High Court in the case of Maxopp Investment Ltd. (supra). Needless to mention that Assessing Officer will allow adequate opportunity of being heard to the assessee.
36. Ground Nos.8 & 8.1 of the assessee's appeal read as under:-
"8. That the assessing officer erred on facts and in law in disallowing deduction under section 80IA of the Act, amounting to Rs.3,32,71,032/-, claimed by the appellant in respect of captive power generating unit at manufacturing facility at Gurgaon.
8.1 That the assessing officer erred on facts and in law in computing profits of the power generating unit by treating the rate of Rs.3.90 per unit, at which power was supplied by State Electricity Board, as the 'market price' of the power, for the purposes of computing deduction under section 80IA of the Act, as against rate of Rs.7.08 per unit (cost of generation of power at Rs.6.16 per unit + mark-up of 15%) adopted by the appellant."
37. At the time of hearing before us, it is submitted by the learned counsel that in view of the power supply constraints in the area of Gurgaon, Haryana, the assessee had set up power plant in order to meet the requirement of power of its manufacturing unit at Gurgaon. That the assessee claimed deduction under Section 80IA at `3.32 crores in respect of power generated at the aforesaid unit and consumed by the manufacturing facility of the assessee company. The deduction claimed was duly supported by the report of the Chartered 39 ITA-5130/Del/2010 Accountant. The assessee computed the profit by adopting the price of the power captively consumed at cost of generation per unit with mark up of 15% which worked out to `7.08 per unit (6.16 + 15% of 6.16). The Assessing Officer, in the assessment order, has held that inter-unit transfer of power from power plant should have been priced at which HSEB i.e. the government body is supplying to the assessee's Dharuhera/Gurgaon plant i.e. at the rate of `3.90 per unit. Since the cost of the generation was more than the market value, there was no profit from the generation of power as per the Assessing Officer. He, therefore, disallowed deduction under Section 80IA. He stated that the Assessing Officer has compared the price with the rate of power supplied by HSEB. That the supply of power by HSEB is not regular and, therefore, the assessee was compelled to set up its own plant for generation of power. Therefore, the market value of the power cannot be compared with the rate at which power is supplied by the government undertaking. He submitted that the Maruti Udyog Limited, an independent supplier of the electricity, generating electricity, was charging rate for supply of power @ `8.50 per unit while the assessee has taken the price at `7.08 per unit. Therefore, the deduction as claimed by the assessee should have been allowed.
38. The learned DR, on the other hand, relied upon the order of the Assessing Officer and the DRP. He stated that the supply of power by Maruti Udyog Limited to its associated enterprises cannot be said to be the market value of the power because the assessee's counsel himself has stated that Maruti Udyog Limited was supplying the power to the associated factories and not to independent parties. Moreover, no evidence for supply of power by Maruti Udyog Limited to any independent party at the rate of `8.50 per unit is produced. He stated that the rate on which the government is supplying power in that area to every industry is in fact the market rate. He, therefore, submitted 40 ITA-5130/Del/2010 that the order of the Assessing Officer in this regard should be sustained.
39. We have carefully considered the submissions of both the sides and perused the material placed before us. Sub-section (8) of Section 80IA reads as under:-
"(8) Where any goods [or services] held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods [or services] held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods [or services] as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods [or services] as on that date :
Provided that where, in the opinion of the Assessing Officer, the computation of the profits and gains of the eligible business in the manner hereinbefore specified presents exceptional difficulties, the Assessing Officer may compute such profits and gains on such reasonable basis as he may deem fit.
[Explanation. - For the purposes of this sub-section, "market value", in relation to any goods or services, means the price that such goods or services would ordinarily fetch in the open market.]."
40. From the above, it is evident that where the goods or services held for the purposes of eligible business are transferred to another business, carried on by the assessee, then for the purpose of deduction under this Section, the profits and gains of such eligible business shall be computed as if transfer had been made at the market value of such goods or services as on date. In the case under appeal before us, it is 41 ITA-5130/Del/2010 not in dispute that in the eligible business, the assessee is generating the power which is being consumed by the assessee company's manufacturing facility. Therefore, the profit of the eligible business is to be computed at the market rate of supply of power. It is the assessee's contention that Maruti Udyog Limited is supplying the power to its AE at the rate of `8.50 per unit while the assessee has computed the profit of the eligible business by taking the rate of power at `7.08 per unit. The assessee has computed the rate of power by the cost of generation per unit with mark up of 15%. However, the Assessing Officer has pointed out that the government undertaking i.e. Haryana State Electricity Board has supplied the power to the assessee and other industrial units in the area at the rate of `3.90 per unit. Now, the question is, what is the market rate at which power is being supplied. In our opinion, the rate at which power is being supplied by the Haryana State Electricity Board, to each and every industrial unit situated in the area, in which assessee's manufacturing unit is situated, is the market rate at which power is available. The rate at which Maruti Udyog Limited is claimed to supply the power to its AE cannot be said to be the market rate of the power in that area because as per assessee's own claim, Maruti Udyog Limited is supplying the power to its AE and not to unrelated parties in general. In view of the above, we hold that the Assessing Officer was fully justified in arriving at the conclusion that there was a loss in the power generation undertaking of the assessee and therefore, there was no eligible profit for allowing deduction under Section 80IA. Accordingly, we dismiss ground Nos.8 & 8.1 of the assessee's appeal.
41. Ground No.9 of the assessee's appeal reads as under:-
42 ITA-5130/Del/2010 "9. That the assessing officer erred on facts and in law in disallowing expenditure of Rs.5.75 crores claimed by the appellant on account of provision for warranty made in respect of sales rendered during the year, on the ground that same is an unascertained liability."
42. We have heard both the parties and perused the material placed before us. We find this issue to be covered in favour of the assessee by the decision of ITAT in assessee's own case for AY 1996-97 vide ITA No.3093/Del/2000 & 2906/Del/2000. In that year, the assessee had claimed a deduction of `28,70,416/- on account of provisions of warranty. The Assessing Officer disallowed the same. On appeal, the CIT(A) deleted the disallowance. Hence, the Revenue was in appeal.
43. The ITAT, vide its order dated 13th May, 2005, upheld the order of the CIT(A) and held as under:-
"56. Keeping in mind the principles laid down by the Hon'ble Supreme Court and also by the Hon'ble Privy Counsel, we shall now examine the facts of the present case. In the present case, the year wise details of provision for warranty and actual payments for the subsequent year against it is as follows:-
F.Y. Warranty provided (Rs.) Warranty paid (Rs.) 1995-96 2,870,415.80 5,123,557.82 1996-97 6,129,755.04 6,249,035.55 1997-98 8,186,166.41 8,275,034.43 1998-99 .......... ...........
The learned CIT(A), on an analysis of the method of making the provisions for warranty has held the actual expenses are being debited every year and a similar basis for making provisions is repeated every year. The system followed by the assessee is consistent. The expenses actually incurred for the previous year and provided for is not less than the actual expenses. Since the method of accounting is scientific and results in correct determination of profits. We are of the view, that the order of the learned 43 ITA-5130/Del/2010 CIT(A), is just and proper and does not call for any interference and the same is therefore, confirmed. Hence, this ground of appeal of the revenue is dismissed."
44. Similar view was taken by the ITAT in AY 1997-98 vide ITA No.3725/Del/2003 & 4028/Del/2003. The same view was followed by the ITAT in 1999-2000 vide ITA No.5511/Del/2003. That the Revenue filed the appeal before the Hon'ble Jurisdictional High Court. However, the Hon'ble Jurisdictional High Court, vide its order dated 20th July, 2007, in ITA No.5305/Del/2003 did not admit the ground relating to deletion of disallowance of warranty fee. In view of the above, we find that the issue of provisions for warranty is settled in favour of the assessee by the decision of ITAT as well as Hon'ble Jurisdictional High Court in assessee's own case. Respectfully following the same, we delete the disallowance made by the Assessing Officer in respect of provisions for warranty. Accordingly, ground No.9 of the assessee's appeal is allowed.
45. Ground Nos.10 to 10.3 are against the disallowance of `12.19 crores being export commission.
46. At the time of hearing before us, it is stated by the learned counsel that similar disallowance is made by the TPO also by way of transfer pricing adjustment and, therefore, ground No.10 should be adjudicated alongwith ground No.1.1 which is against the adjustment made by the Assessing Officer as per the order of the TPO.
47. The learned DR also accepted this submission of the learned counsel. Therefore, we shall adjudicate ground No.10 of the assessee's appeal alongwith ground No.1.1 of its appeal.
44 ITA-5130/Del/2010
48. Ground Nos.1 to 5 of the assessee's appeal are with regard to adjustments made by the Assessing Officer as per the order passed by the TPO.
49. Ground No.1 of the assessee's appeal is of general nature and it is admitted by the parties that no separate adjudication of ground No.1 is required.
50. Ground No.1.1 of the assessee's appeal reads as under:-
That the assessing officer erred on facts and in law in making adjustment of Rs.57,24,42,096 to the income of the appellant on account of the following international transactions on the basis of the order passed by the Transfer Pricing Officer ("the TPO") under section 92CA(2) disregarding the bench marking analysis applying TNMM undertaken by the appellant :
S.No. International Amount of Arm's length Difference Transactions international price of the transaction international shown by the transaction assessee determined by TPO
1. Payment of Export 12,18,78,393 NIL 12,18,78,393 Commission
2. Payment of Model Fee 52,57,69,473 13,14,42,368 39,43,27,105
3. Royalty paid on exports 4,08,32,068 NIL 4,08,32,068 made to the AEs
4. Purchase of raw 81,10,78,331 79,56,73,801 1,54,04,530 material, spare parts and components Total 57,24,42,096 45 ITA-5130/Del/2010
51. Ground Nos.1.2 to 5 are either the arguments of the assessee or the repetition of ground No.1.1. Therefore, it was stated by the learned counsel that if ground No.1.1 is adjudicated, it will take care of ground Nos.1.2 to 5 also. Accordingly, we proceed to adjudicate the various adjustments made by the TPO which is challenged by the assessee vide ground No.1.1 of its appeal.
52. The first adjustment is with regard to payment of export commission of `12,18,78,393/- which is disallowed by the TPO by determining the arm's length price at nil. However, the Assessing Officer also disallowed it on various alternative grounds:-
(a) He held this amount to be royalty/fee for technical services.
Since the assessee did not deduct the tax at source under Section 195, he disallowed the amount under Section 40(a)(i).
(b) The export agreement was for the benefit of HMCL and not the assessee company, therefore, the payment of export commission was held to be not allowable under Section 37(1).
(c) The export agreement is in the nature of license acquired by the assessee for the purpose of making export to other countries where HMCL had exclusive privilege to operate. The license is for a longer period of time and, therefore, it constitutes an intangible asset. Accordingly, the expenditure was held to be a capital expenditure.
53. The disallowance made by the Assessing Officer under the transfer pricing provision is challenged vide ground No.1.1 reproduced above and the disallowance made under the general provisions of the IT Act have been challenged by way of ground Nos.10 to 10.3 which read as under:-
46 ITA-5130/Del/2010 "10. That the assessing officer erred on facts and in law in disallowing export commission paid to Honda, amounting to Rs.12.19 crores, by applying provisions of section 40(a)(ia) on the ground that the appellant had failed to deduct tax at source therefrom as per section 195 of the Act.
10.1 That the assessing officer erred on facts and in law in holding that the payment of export commission was in the nature of royalty/fee for technical services chargeable to tax in India under section 9(1)(vi)/(vii), since the same was in consideration for (i) right to use trademark, (ii) permission to export and (iii) in lieu of managerial and technical services provided by Honda, and accordingly, the appellant was under the obligation to deduct at source therefrom as per section 195 of the Act.
10.2 That the assessing officer erred on facts and in law in alternatively holding payment of export commission to be in the nature of capital expenditure not allowable under section 37(1) of the Act on the ground that the same was incurred for acquiring permission/license for making export.
10.3 Without prejudice, that the assessing officer erred on facts and in law in not allowing depreciation on the amount of export commission disallowed, which was treated as capital expenditure."
54. First we shall consider the disallowance made under the transfer pricing provision by the TPO. The facts of the case are that during the year under consideration, on the export of motorcycles, the assessee paid export commission at the rate of 5% to Honda Motor Co.Ltd., Japan. On reference by the Assessing Officer, the TPO held that the payment of export commission is simply a mechanism to shift profit out of India to overseas AEs and the transactions are not at arm's length. Accordingly, he came to the conclusion that no export commission was required to be paid by the assessee and the entire payment of export commission was disallowed by way of TP adjustments. The DRP also upheld the disallowance proposed by the 47 ITA-5130/Del/2010 TPO. Accordingly, the Assessing Officer disallowed the payment of export commission at `12,18,78,393/-. Hence, this appeal by the assessee.
55. At the time of hearing before us, the learned counsel for the assessee argued at length and he also submitted in writing the broad propositions of his arguments. We deem it proper to reproduce the same herein below:-
"A. A. Payment of export commission :
Under Technical Know How Agreement the appellant was entitled to use technical know-how provided by Honda Motor Co.Ltd., Japan (HMCL) for manufacture and sale of two wheelers and parts in India and was not authorized to sell its products or parts in any other territory than in India without the prior written consent of HMCL. The technical know-how agreement was approved by the concerned Ministry of the Government vide letter dated 06-09-2004. The appellant had entered into a separate Export agreement dated 21.06.2004 under which HMCL accorded consent to the appellant to export specific models of two wheelers to certain countries on payment of export commission @ 5% of the FOB value of such exports.
The appellant has demonstrated the international transactions of payment of export commission to HMCL as being at arm's length, as under:
i) The payment of export commission was made by the appellant to HMCL as consideration for according consent to the appellant to export two wheelers in the overseas territory (ies), which were earlier being supplied by HMCL or its other affiliates. In other words, the payment of commission was made to HMCL in lieu of HMCL agreeing to cede the overseas market. The Hon'ble Delhi Bench of the Tribunal in the case of Honda Siel Cars Ltd. vs. ACIT : 109 ITD 1 for the assessment year 2001-02 and 2002-03, held that similar expenditure on payment of commission on export was incurred exclusively for the purpose of the business of the appellant and did not constitute diversion of profit by the appellant to HMCL.
48 ITA-5130/Del/2010
ii) It is a matter of record that the appellant does not have any distribution or marketing network outside India and it solely depends on distribution network/marketing support provided by the AEs for export of its products. The appellant company, it would be appreciated, makes payment of export commission to the AE for enabling it to access its well established overseas marketing network/territories for exporting appellant's products from India. The export commission is also paid by the appellant to HMCL for procuring export orders using their network and infrastructure in relation to exports. The fact that the appellant is able to sell its products in the overseas market clearly demonstrates and establishes that the necessary distribution network and market support was provided by the associated enterprise, i.e., HMCL.
iii) The net price realized from such exports, after reducing therefrom the export commission paid to HMCL is higher than the price realized from domestic sales of two wheelers to the dealers in India.
iv) Additional benefit on exports (over and above the domestic price after reducing royalty and export commission) amounted to Rs.13.05 crores. The appellant could earn additional margin from exports as sales price from export was higher than the domestic sales, even after payment of export commission and royalty to the on such exports.
v) It is respectfully submitted, that the appellant is free to conduct business in the manner that appellant deems fit and the commercial or business expediency of incurring any expenditure is to be seen from the appellant's point of view. Attention in this regard is invited to the following decisions:
• JK Woolen Manufacturers v. CIT : 72 ITR 612 (SC). • CIT v. Dalmia Cement (P) Ltd. : 254 ITR 377 (Del). • CIT vs. Padmani Packaging (P) Ltd. : 155 Taxmann. • S.A.Builders Limited vs. CIT : 288 ITR 1 (SC). • CIT vs. Dalmia Cement (B) Ltd. (supra), (Del).
Reliance may be placed on the decision of DCIT vs Ekla Appliances : (2011-TII-37-ITAT-Del-TP) wherein the Hon'ble Tribunal held that the TPO cannot challenge the judgment
49 ITA-5130/Del/2010 of the assessee as to the source from which the technology is to be obtained and at what cost etc. The Hon'ble Delhi High Court while upholding the decision of the Hon'ble Tribunal held that as long as an expense is incurred wholly and exclusively for the purpose of business, it is irrelevant as to whether such expenditure actually results in profit or not. The Hon'ble High Court held as under:
"21. The position emerging from the above decisions is that it is not necessary for the appellant to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not necessary for the appellant to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above.
XXX So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorized."
The Hon'ble Tribunal recently in the case of M/s Ericsson India Pvt.Ltd. vs. DCIT (ITA No.5141/Del/2011), too, following the law laid down by the Hon'ble Jurisdictional High Court, held that "it would be wrong to hold that the expenditure should be disallowed only on the ground that these expenses were not required to be incurred by the assessee."
Further, in the case of Dresser Rand India Pvt.Ltd. vs Addl.CIT (ITA No.8753/Mum/2010) the Hon'ble Mumbai Bench of the Tribunal held that benefits derived by the 50 ITA-5130/Del/2010 appellant is not a relevant criteria for determination of arm's length of an expenditure incurred by the appellant.
Further, in the case of LG Polymers India Pvt.Ltd. vs. Addl. CIT (ITA No.524/Vizag/2010), the Hon'ble Visakhapatnam Bench of the Tribunal held as under:
"13. We agree with the views of the Learned A.R. on this issue. As submitted by him, it is the prerogative of the appellant to regulate its business affairs and it is not open for the department to question the same. Similar views have been expressed by the Hon'ble Supreme Court in the case of Dhanrajgiriji Raja Narasingirji, referred (Supra)."
Reliance in this regard is placed on the decision of Ahmedabad Bench of Tribunal in the case of KHS Machinery (P) Ltd. vs. ITO : 146 TTJ 692, wherein the Hon'ble Tribunal on the issue of disallowance made by the TPO of payment of royalty, has held as under:
"The assessee had not made the one-time payment but making the continuous payment to the know-how provider which has been accepted by the Department in the past. The assessee has been charging 5 per cent royalty on each and every transaction and therefore the said payment cannot be said to have been paid on the aggregate amount, as argued by learned CIT-Departmental Representative. The findings of the AO in considering the royalty charges as nil as ALP cannot be accepted since the AO in the present case has not brought on record, the ordinary profits which can be earned in such type of business. Therefore in our view the payment of royalty is not hit by the provisions of s. 92 of the Act and there is no reason to hold that the expenses should not be allowed under s. 37(1) of the Act, since the expenditure has been incurred by the assessee during the course of business and is having the nexus with the business of the assessee. Therefore the payment of royalty is a business expenditure which has been incurred wholly and exclusively for the purpose of business of the assessee and same is to be allowed in toto as a matter of commercial expediency. Therefore, the case laws relied upon by the learned CIT- Departmental Representative are of no benefit to the Revenue. The reasonableness of expenditure in the present circumstances and facts of case cannot be doubled and accordingly the AO is directed to allow the claim of the
51 ITA-5130/Del/2010 assessee and the order of learned CIT(A) is reversed. Thus, ground no.3 of the assessee is allowed."
In addition to the aforesaid, it is respectfully submitted that, in all cross sections of industry, business enterprises engage export agents for securing export orders or for promoting/selling their products outside India. The Exchange Control Guidelines issues by Reserve Bank of India permit payment of export commission upto 12.5% of the invoice value.
vi) The TPO in his order has erroneously held the arm's length price of international transactions of payment of export commission to be NIL applying CUP method. The TPO, it is respectfully submitted, in fact, did not place on record any comparable uncontrolled transaction for application of CUP method. In fact, arm's length price of international transactions of payment of export commission has been determined by the TPO at NIL, entirely based on conjecture and surmises and without application of any of the prescribed methods. Further, in the case of Ekla Appliances Ltd. (supra) the Hon'ble Delhi High Court held that whether an expenditure results in any benefit to the appellant or not is not a relevant consideration while applying CUP method. The Hon'ble High Court held as under:
"22. Even Rule 10B(1)(a) does not authorize disallowance of any assessment proceedings on the ground that it was not necessary or prudent for the appellant to have incurred the same or that in the view of the Revenue the expenditure was unremunerative or that in view of the continued losses suffered by the appellant in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B."
The adjustment made by the TPO on account of payment of export commission, therefore, is without any basis and is in any case inconsistent with the scheme of Transfer Pricing assessment under section 92CA of the Act. The DRP in the case of Honda Seil Power Products vs. ACIT for the assessment year 2007-08 vide order dated September 26, 2011, while upholding the contention of the assessee for payment of export commission under similar 52 ITA-5130/Del/2010 circumstances deleted the adjustment proposed by the TPO."
56. The learned DR, on the other hand, relied upon the orders of the TPO, Assessing Officer as well as the DRP. He submitted that the AE has allowed the assessee to export motorcycles only to designated countries, viz., Chile, Peru, Columbia, Sri Lanka, Bangladesh, Oman, UAE, Qatar, Kenya, Benin and Burundi. All these countries are underdeveloped countries and the associated enterprise has no manufacturing base there but the subsidiaries of associated enterprise are engaged in the distribution work of Honda vehicles. The AE has permitted the assessee to export to these countries just to support the subsidiaries who are engaged in the distribution work of Honda vehicles in those countries and to take advantage of low cost of production in India. Moreover, the assessee is required to conduct the service campaign of products in those countries at its own cost. Therefore, at the cost of the assessee, the market for Honda products was promoted in those countries. That the assessee was not entitled to export each and every model but it was required to export only certain models as was permitted by Honda Motor Co.Ltd. The assessee was also required to bear the warranty cost. These facts clearly prove that the assessee was required to export motorcycles to underdeveloped countries in a very restrictive business environment and it was required to incur additional cost for promoting the market of Honda products. Inspite of these detrimental terms and conditions and the benefit to the subsidiaries of the AE, the AE has charged export commission from the assessee. This clearly proves that the payment of export commission was simply a mechanism to shift profit out of India to overseas AEs. On these facts, the TPO has rightly held that the assessee was not required to pay any commission on export and, therefore, the arm's length price of the export commission was nil.
53 ITA-5130/Del/2010
57. The learned DR has also pointed out that the RBI guidelines permitting the export commission up to 12.5% would not be binding upon the income tax authorities.
58. He further submitted that the learned counsel's argument, that the TPO has not applied any method while determining the arm's length price and, therefore, the order of the TPO is not sustainable in law, is incorrect because the TPO has held that no commission is required to be paid by the assessee. In such circumstances, there is no question of determination of the amount of commission payable at arm's length. The question of application of any method for determining the arm's length commission would arise only if the commission is payable.
59. We have carefully considered the arguments of both the sides and perused the material placed before us. The assessee, under the technical know-how agreement dated 2nd June, 2004 with HMCL, was entitled to use technical know-how provided by HMCL for manufacture and sale of two wheelers and parts in India and was not authorized to sell its products or parts in any other territory than in India without the prior written consent of HMCL. That Article 2 of the agreement reads as under:-
"Article Article 2 (Grant of License and Exclusivity) Subject to the terms and conditions herein contained, LICENSOR hereby grants to LICENSEE an indivisible, non- transferable and exclusive right and license, without the right to grant sublicenses, to manufacture, assemble, sell and distribute the Products and the Parts during the term of this Agreement within the Territory under the Intellectual Property Rights and by using the Technical Information. Provided, it is acknowledged by LICENSEE, (i) 54 ITA-5130/Del/2010 the exclusivity granted herein is against the third parties but not HMSI, and (ii) the exclusivity against HMSI is only with respect to the exterior of the Products.
It is argued between the parties that subject to the terms hereof, the LICENSOR shall make necessary endeavours so that New Model(s) for the LICENSEE are introduced in a phased and timely manner in order to meet the request from the LICENSEE and such introduction would be on reasonable criteria."
60. From the above, it is evident that the assessee is granted license to manufacture, assemble, sell and distribute the products and parts within the "territory". That Article 1(6) of the agreement defines the "territory" as "The term "Territory" shall mean the Republic of India". Therefore, as per the agreement between the assessee and HMCL dated 2nd June, 2004, the assessee was entitled to sell and distribute the product and the parts only within India. Thus, it was not entitled to export the product. However, the assessee entered into a separate agreement termed as 'export agreement' with HMCL on 21st June, 2004. By way of Article 2 of the export agreement, HMCL gave its consent for the export of the goods to the designated countries. The relevant portion of Article 2 of export agreement reads as under:-
"Article 2. (Consent to Export) 2.1 Subject to the terms and conditions herein contained, LICENSOR hereby gives consent to the export to the Designated Country by LICENSOR, however without a right to re-export;
(i) of the Products for the sale thereof within the Designated Country only.
(ii) of the Component Parts for the assembly of the Products therein and for the sale thereof within the specific Designated Country only, and
(iii) of the Service Parts only for the purpose of repair or replacement of the Products exported to and sold in the 55 ITA-5130/Del/2010 Designated Country by LICENSEE hereunder. In this connection, it is agreed to by LICENSEE that LICENSOR and third parties may also export the Products and the Service Parts to and sell them in the Designated Country."
61. Article 5 of the export agreement provides the consideration would be 5% of the export price. The relevant portion of Article 5 reads as under:-
"Article 5. (Consideration) 5.1 In consideration of the consent and the assistance given by LICENSOR hereunder, LICENSEE shall pay to LICENSOR a commission in an amount equivalent to five (5) percent of the export price, F.O.B. port of the Territory, of each of the Products shipped by or on behalf of LICENSEE for export hereunder; provided that such consideration becomes payable only when the relevant distributor is a distributor of LICENSOR. Commissions against export to Nepal and Bhutan shall be paid subject to the local regulations/Approvals in India."
62. In view of the above export agreement, during the accounting year relevant to the assessment year under consideration, the assessee made export to several countries as permitted in the export agreement and paid 5% commission on the FOB value of the export sales. The TPO was of the opinion that the assessee did not derive any benefit from the export. On the other hand, the subsidiaries of the AEs who are engaged in the distribution work of Honda vehicles in those countries derived the benefit. It would be appropriate to reproduce the relevant portion of the order of the TPO in this regard:-
"Who has received benefit of Export Commission?
The AE has allowed the assessee to export motorcycles only to the designated countries viz. Chile, Peru, Columbia, Sri Lanka, Bangladesh, Oman, UAE, Qatar, Kenya, Benin and Burundi where the AE has not manufacturing base but 56 ITA-5130/Del/2010 has subsidiary engaged in distribution work of Honda vehicle. In order to support these subsidiary and enjoy benefit of low cost of production in India the AE under an agreement asked the assessee to make exports in those countries. It is evident from these facts that the sole purpose of allowing the assessee to export in these countries is as under:
(a) To support the existing subsidiaries and group companies in various countries engaged in distribution activities,
(b) To transfer the benefit of locational savings to these subsidiaries/group companies,
(c) To promote market for Honda products in these countries.
However, in-spite of using the assessee for these benefits of the subsidiaries and group companies, the AE has charged an export commission. During the course of proceedings no evidence to support a claim that the assessee has obtained any benefit in lieu of export commission and that payment of export commission was at arm's length price, was filed. Now the issue is whether such commission was paid in lieu of services rendered by the AEs and whether such commission is at arm's length price. In my view no third party would agree to such detrimental conditions as agreed by the assessee in the Export Agreement and for this reason the theory of form versus substance was examined in this case.
Now a question will arise as to what are detrimental conditions to the assessee. The answer is available through the following facts:
(a) The assessee is not able to export any model which it wants to export but it was required to export certain prescribed models. (Article 2.3 of the agreement dated 21.06.2004).
(b) It cannot use any other distributor except for group companies/subsidiaries. This has greatly restricted the scope of the assessee to earn a desired profit. (Article 4.2 of the Export agreement dated 21.06.2004).
57 ITA-5130/Del/2010
(c) The assessee is also expected to bear the warranty cost. (Article 7.5 of the agreement dated 21.06.2004).
(d) The assessee is required to conduct service campaign of the products in these countries at its own cost. (Article 7.7 of the agreement dated 21.06.2004).
The above facts clearly prove that the assessee is exporting motorcycles in a very restrictive business environment wherein it has incurred additional cost as mentioned above. In-spite these detrimental terms and conditions and proven facts of benefit to the AE and group companies the AE has charged export commission. This clearly proves that the international transactions of export commission are not at arm's length price.
Taking a holistic view of the issue, I am of the considered view that the payment of export commission is simply a mechanism to shift profits out of India to overseas AEs and the transactions are not at arm's length."
63. Let us now examine whether by way of export agreement, the assessee was benefited or the export agreement was for the benefit of the subsidiaries of the AEs. The assessee, in its reply dated 21.10.2009 addressed to the Assessing Officer, explained the reason for payment of export commission and benefit derived by it from such export, the relevant portion of which reads as under:-
"The expenditure incurred was therefore, incurred wholly and exclusively for the purpose of business notwithstanding that the same has been paid to the collaborator for export made to a group company.
The assessee company, it would be appreciated, makes payment of export commission to HMCL for enabling it to access its well established overseas marketing network/territories for exporting assessee's products from India. It has been submitted that the net price realized from such exports, after reducing therefrom the export commission paid to HMCL is higher than the price realized from domestic sales of two wheelers to the dealers in India.
58 ITA-5130/Del/2010 Enclosed at Annexure-I is a chart showing modelwise detail of domestic price and export price including detail of additional revenue/profits earned by the assessee from exports during the year. It would be seen from the above chart that additional benefit on export (over and above the domestic price after reducing royalty and export commission) amounted to Rs.13.05 crores. Thus, it would be clear from the aforesaid chart that the assessee could earn additional margin from exports as sales price from export was higher than the domestic sales, inspite of paying export commission and royalty to the collaborator."
64. The above reply is at pages 299 & 300 of the assessee's paper book. At page 345 of the paper book, the assessee has enclosed the annexure by which a detailed working is given, how the assessee derived the benefit of `13.05 crores by the export. Neither the Assessing Officer nor the TPO in their respective orders have disputed the correctness of the above working by the assessee. Even at the time of hearing before us, the learned DR has not disputed the above working. From Annexure-1 which is at page 345 of the assessee's paper book, it is evident that assessee has given the model-wise details of export i.e. the quantity of each model, domestic sale value and export sale value and the difference. For ready reference, the Annexure-1 of this order.
copy of the Annexure is enclosed as Annexure-
Therefore, the allegation of the Revenue that export agreement between the assessee and HMCL was not for the benefit of the assessee and by way of export, instead of the assessee, the subsidiaries of the AEs have been benefited, is factually incorrect. The assessee is manufacturing motorcycles under the technical know-how agreement between it and HMCL which was entered into by the assessee and HMCL in the year 1984 and then renewed in 1994 and 2004. That as per technical know-how agreement, the assessee was entitled to manufacture and sell the motorcycles within the territory of India only. By way of export agreement, the assessee has been permitted to export the motorcycles manufactured by it in India to 59 ITA-5130/Del/2010 certain designated countries. We are unable to understand the logic of the Revenue that such an export agreement was not for the benefit of the assessee. Clearly, by this export agreement, the assessee was permitted to export in certain countries. Without this export agreement, the assessee was not able to export even to those countries. The contention of the Revenue that by way of export to those countries the subsidiaries of the AEs situated in those countries were benefited and not the assessee, is again factually incorrect because it is the assessee who received the sale consideration on sale of vehicles. It has not paid any amount to the subsidiaries of the AEs for utilizing their distribution network because as per export agreement, vide Article 4.2 which reads as under, the assessee was entitled to use the marketing network of subsidiaries of HMCL:-
"4.2 LICENSOR agrees that LICENSEE will utilize the distribution and service network established by distributor(s) of LICENSOR Goods, and LICENSEE hereby agrees to ship and make all its exports of the Products and the Service Parts for the Designated Country to (if the distributor in the Designated Country is the exclusive distributor or, even if a non-exclusive distributor, the only distributor in the Designated Country) the distributor for the LICENSOR Goods or (if there are more than one distributor) the distributor that LICENSOR will designate after mutual consultation with LICENSEE, in the Designated Country. In the event any distributor for the LICENSOR Goods in a Designated Country is disqualified to act as such distributor for any reason whatsoever, LICENSEE agrees to ship and make all its exports of the Products and the Service Parts for such Designated Country to a distributor, only, appointed by LICENSOR for the LICENSOR Goods in place of such disqualified distributor."
65. In the details filed before the Assessing Officer, the assessee has given model-wise details to show that the sale consideration of the export of each model was more than the domestic rate and even after considering the export commission, it was more than the domestic 60 ITA-5130/Del/2010 rate. The TPO has also held that under the export agreement, the assessee has agreed to various conditions which are detrimental to the assessee and, therefore, the assessee is not required to pay any export commission. The first point mentioned by the Assessing Officer to arrive at this conclusion is that the assessee is not able to export any model which it wants to export but it was required to export certain prescribed models. However, without the export agreement, the assessee was not able to export any of the models. It is only because of the export agreement the assessee is permitted to export the specified models to the specified countries. Therefore, the export agreement has benefited the assessee and not detrimental to the assessee as alleged by the Assessing Officer. The second condition pointed out by the TPO is that the assessee cannot use any other distributor except the group companies and the subsidiaries. We have already pointed out that in fact the assessee is benefited by using the marketing network of the subsidiaries of HMCL because the assessee has not paid any amount to the subsidiaries of AEs. If the assessee utilizes the services of any other person, it would have been required to pay for those services. The TPO has also mentioned that the assessee is expected to bear the warranty cost. However, such warranty cost is to be borne by the assessee even in the case of domestic sale. Even otherwise, the warranty cost is always to be borne by the manufacturer. The TPO has also referred to paragraph 7.7 of the export agreement to point out that the assessee is required to conduct service campaign of its products in those countries. Paragraph 7.7 reads as under:-
"7.7 If reasonably requested by any Distributor, LICENSEE shall at its discretion conduct a service campaign, in respect of the Products and in the relevant Designated Country. Any reasonable costs/expenditure to be incurred or spent in this regard shall be duly decided by the LICENSEE at its sole discretion."
61 ITA-5130/Del/2010
66. From the above, it is evident that first of all it is to be requested by the distributor that a service campaign is required and then the assessee has a discretion to conduct or not to conduct such campaign. In case any such campaign is conducted, then the expenditure in this regard would be borne by the assessee. In our opinion, this clause cannot be said to be a detrimental condition as stated by the TPO in his order. The TPO has disallowed the entire export commission on the ground that the export agreement was not for the benefit of the assessee but detrimental to the interest of the assessee. Therefore, no export commission is required to be paid. After considering the entire facts, we are of the opinion that the export agreement was for the benefit of the assessee and not detrimental to the interests of the assessee. By virtue of the export agreement, the assessee was able to export the specified models of the two wheelers to the specified countries. It is true that by virtue of the export agreement, the assessee was not permitted to export any of the models to any of the countries. However, even by export of specified models to the specified countries, the assessee has benefited and the assessee has given the detailed working of such benefit which is also enclosed as Annexure-
Annexure-1 to this order. As per this working, the assessee derived the benefit of `13.05 crores by the export. The export sale rate was more than the domestic sale rate even after considering the export commission. In view of the above, we are unable to uphold the disallowance of commission by the Assessing Officer by way of transfer pricing adjustment.
67. Now, we come to disallowance of export commission under the general provisions of the Income-tax Act. After the detailed discussion, the conclusion of the Assessing Officer in this regard is at page 26 of his order which reads as under:-
62 ITA-5130/Del/2010 "7.16 Export agreement mentions that the consideration payable under the agreement is a composite one including payment for permission, which is a commercial right being property of HONDA arising out of it being holder of information, payment for use of brand name which is a intellectual property right being held by HONDA and the services. These services which are evident from the export agreement are more in nature of managerial and consultancy and if the technical collaboration agreement is considered then primarily HONDA is duty bound to provide after sales services. None of these payments can be properly classified as export agency commission. In light of clear cut definition of royalty and fee for technical services given under the Income Tax Act as discussed above the payment is towards royalty/fee for technical services because the payment is as a consideration for right to use trademark, permission to export and in lieu of managerial and technical services provided by Honda and accordingly the assessee was under obligation to have deducted the tax under section 195 of the income Tax Act. Non deduction of tax at source makes the entire payment of Rs.12.19 crores as not an allowable deduction u/s 40A(i) of the Income Tax Act. The amount is therefore disallowed and added to the income of the assessee.
7.17 Alternatively, the whole arrangement when viewed in totality would reveal that the Honda directed exports to specified territories are more for the purpose of Honda than the assessee company and therefore also the same cannot be allowed u/s 37(1) of the Income Tax Act as deduction. Even otherwise the expenditure is primarily towards gaining the permission or license of Honda for the purpose of making export to the countries where Honda has exclusive privilege to operate. This purely is in the nature of license acquired by the assessee for the purpose of utilization to engage in the business activity. The license is for a longer period of time and therefore constitutes a capital asset by way of intangible rights provided u/s 32(1) of the Income Tax Act. Viewed from this aspect also the expenditure is in nature of capital expenditure and therefore not allowable u/s 37(1) of the Income Tax Act. Therefore, an addition of Rs.12.19 crores is made to the total income of the assessee.
63 ITA-5130/Del/2010 However, in any case the TPO vide its order dated 30-10-
2009 has discussed this issue in detail and disallowed the same. Accordingly, the amount of Rs.12.19 crores is added to the total income of the assessee."
68. At the time of hearing before us, it is stated by the learned counsel that the payment made to HMCL in terms of the export agreement was on account of consent granted by HMCL to the assessee to export out of India to certain designated countries. Thus, the export commission was not for use of any copyright, patent, trademark etc. The payment is, therefore, not in the nature of royalty. He further stated that the payment is not in the nature of fees for technical services since the same was not paid in lieu of rendering any services much less services of a managerial, technical or consultancy nature. In support of this contention, he relied upon the decision of Authority for Advance Ruling in the case of Spahi Project P.Ltd. - 315 ITR 374. He further submitted that even if the payment of export commission is regarded as royalty/fees for technical services, since the commission paid is related to services utilized for earning income from a source outside India, the same cannot be deemed to arise or accrue in India. Therefore, the export commission paid to a non-resident is not chargeable to tax in India. When the payment is not chargeable to tax in India, the question of deduction of tax under Section 195 does not arise.
69. With regard to the observation of the Assessing Officer that the payment is not relating to business and therefore disallowable under Section 37(1), it is stated by him that the payment is made in pursuance to the export agreement. Without the export agreement, the assessee was unable to export the goods. It is the export agreement which entitled the assessee to export the goods. By exporting the goods to other countries, the assessee had been 64 ITA-5130/Del/2010 benefited. He, therefore, submitted that the export agreement was for the purpose of business and consequently, the payment for export commission was also incurred wholly and exclusively for the purpose of assessee's business. He further stated that by the export agreement, the assessee does not acquire any capital asset because under the export agreement, the assessee merely received permission to export products outside India. There is no transfer of any asset by HMCL to the assessee. The assessee has not obtained any title or ownership of any asset, whether tangible or intangible. He, therefore, submitted that the disallowance of export commission either under the transfer pricing provision or under the general provision of the Income-tax Act is uncalled for.
70. The learned DR, on the other hand, in addition to relying upon the assessment order, has stated that the assessee has entered into two agreements with HMCL. First is a license and technical assistance agreement and the second is an export agreement. Both the agreements have to be read together as a part of total arrangement between the parties. The nomenclature given to both the agreements shall not determine its treatment under the taxing statutes. It is the reality of the transactions and the relationship of the parties which will determine the nature of payment made. From the cumulative effect of the two agreements and conditions mentioned therein, it is clear that the payment made is clearly in the nature of royalty/fees for technical services. Since it was royalty/fees for technical services paid to non- resident, the assessee was required to deduct the tax under Section
195. Once the assessee failed to deduct the tax as required under Section 195, disallowance under Section 40(a)(ia) made by the Assessing Officer was quite justified. That if the above view of the Revenue is not accepted, then the amount is disallowable under Section 37(1) also because by the export agreement, it is only the 65 ITA-5130/Del/2010 HMCL which is benefited and not the assessee and, therefore, so far as the assessee is concerned, it is not the expenditure incurred for the purpose of business. He alternatively stated that the payment should be treated as a capital expenditure because by the export agreement, the assessee acquired the license to export for a longer period of time which itself is an intangible asset i.e. a capital asset.
71. We have carefully considered the arguments of both the sides and perused the material placed before us. While considering the adjustment made by the TPO in respect of export agreement, we have discussed both these agreements. The technical know-how agreement was entered into between the assessee and HMCL in the year 1984 which was renewed in the year 1994 and then in 2004. Under the technical know-how agreement, the assessee was permitted to manufacture, assemble, sell and distribute the products within the territory which was defined as Republic of India. Thus, since 1984 to 2004, the assessee was not allowed to export any product. The export agreement was entered into with HMCL only on 21st June, 2004 by which HMCL gave its consent for export of the goods to the designated countries on the payment of export commission. Therefore, the contention of the Revenue that cumulative effect of the two agreements is to be considered cannot be accepted. Both the agreements were entered into in different parts of time, one in the year 1984 and, the other in the year 2004 and both the agreements operate under different fields. By the first agreement, HMCL provided technical know-how for manufacture and sale of two wheelers within the territory of India. By the export agreement, HMCL permitted the assessee to export the designated goods to the designated countries outside India. Therefore, both the agreements are to be interpreted independently. On the perusal of the export agreement, we are unable to agree with the Revenue that the export agreement is in the nature 66 ITA-5130/Del/2010 of royalty or fees for technical services. We find that the Authority for Advance Ruling has considered the issue of TDS on the export commission in the case of Spahi Project P.Ltd. (supra). In that case, the facts are that the assessee, an Indian company engaged in the manufacturing and supply of industrial pesticides, proposed transactions with Zaikog, a non-resident company incorporated in South Africa, which promoted and distributed various products. Zaikog offered its services to promote and market a product for termite control. And for this Zaikog was to receive a commission of 3% on every completed transaction. The role of Zaikog was to communicate the details of the interested parties to the applicant which would pursue the proposal for confirmed orders which were to be executed directly by the applicant. The sale consideration was to be received in India by the applicant and the commission was payable to Zaikog in India. On these facts, the assessee sought the ruling of the Authority on the following questions, inter alia:
(a) whether the amounts proposed to be paid by the applicant to Zaikog were subject to deduction of tax at source under section 195 of the Income-tax Act, 1961;
(b) whether the amounts to be paid by the applicant to Zaikog were taxable in the hands of Zaikog, which did not have a permanent establishment in India; and
(c) whether the amount payable to Zaikog would be taxable as fees for technical services in India.
On these facts, the Authority ruled as under:-
"(i) That, in view of Circular No.23, dated July 23, 1969, and No.786 dated February 7, 2000 ([2000] 241 ITR (St.)
132), which reiterated that circular, issued by the Central Board of Direct Taxes, the payments made to Zaikog
67 ITA-5130/Del/2010 towards commission for services rendered by it abroad were not liable to be taxed in India either under the Income-tax Act, 1961, or under the Double Taxation Avoidance Agreement between India and South Africa (DTAA). Consequently, the applicant was not liable to deduct tax at source under section 195 of the Act. Viewed from the angle of section 9(1) of the Act, Zaikog did not earn any income or account of business connection in India. Nor could Zaikog be subjected to tax in India in the absence of a permanent establishment in India.
(ii) That Zaikog would not be rendering services of a managerial, technical or consultancy nature and, therefore, liability to tax could not be fastened on it by invoking the provisions dealing with fees for technical services."
72. The ratio of the above decision of Authority for Advance Ruling would be squarely applicable to the case of the assessee. Even otherwise, as per the provisions of the Income-tax Act, the export commission paid by the assessee would not fall within the ambit of either royalty or fee for technical services. The 'royalty' has been defined in Explanation-2 after Section 9(1)(vi) of the Income-tax Act, which reads as under:-
"Explanation 2. - For the purposes of this clause, "royalty"
means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head "Capital gains") for -
(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property;
(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property;
68 ITA-5130/Del/2010
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill;
[(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;]
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to [(iv), (iva) and]
(v)."
73. Similarly, 'fee for technical services' has been defined by way of Explanation-2 after Section 9(1)(vii) of the Income-tax Act. From a plain reading of the above definitions of 'royalty' as well as 'fee for technical services', it would be evident that the payment of export commission would not fall in any of the above definitions. By way of technical agreement, the assessee received the technical know-how to manufacture, assemble, sell and distribute the two wheelers within the territory of India. The payment made in pursuance to such agreement was royalty and has been treated by the assessee itself as royalty. By way of second agreement i.e. export agreement, HMCL permitted the assessee to export the specified two wheelers to the specified countries. Therefore, by export agreement, the assessee has not been transferred or permitted to use any patent, invention, model, design or secret formula. Similarly, HMCL, by way of export agreement, has not rendered any managerial, technical or consultancy services. In view of 69 ITA-5130/Del/2010 the above, we hold that export commission was neither royalty nor fee for technical services and, therefore, the assessee was not required to deduct tax at source on the payment of export fee. Once the assessee was not required to deduct the tax at source, it cannot be said that the assessee failed to deduct tax at source so as to apply Section 40(a)(ia).
74. While considering the disallowance made by the TPO by way of transfer pricing adjustment, we have discussed at length and have arrived at the conclusion that the export agreement was for the benefit of the assessee and not detrimental to the assessee. Therefore, the finding of the Assessing Officer that the expenditure incurred by the assessee by way of export agreement was not incurred for the purpose of business of the assessee cannot be upheld. We hold that the export commission paid by the assessee was for the purpose of assessee's business.
75. The Assessing Officer has alternatively held the payment of export commission to be capital expenditure. After considering the arguments of both the sides and the facts of the case, we are unable to accept this view of the Assessing Officer. By way of export agreement, HMCL has only permitted the assessee to export the specified goods to the specified countries, that too, subject to running payment of the export commission. The assessee has not acquired any asset or even the intangible right in the nature of a capital asset. The Assessing Officer has disallowed the royalty payment paid by the assessee by way of technical know-how agreement holding the same to be capital expenditure. From paragraph No.7 to paragraph No.29, we have discussed at length and have come to the conclusion that the payment of running royalty cannot be said to be capital expenditure. While doing so, we have also relied upon several decisions of Hon'ble Jurisdictional High Courts at pages 17 to 24. For the sake of brevity, 70 ITA-5130/Del/2010 we are not reproducing the same again but, we reiterate that the ratio of those decisions in the cases of Lumax Industries Ltd. (supra), Shriram Pistons & Rings Ltd. (supra), Sharda Motor Industrial Ltd. (supra), J.K.Synthetics Ltd. (supra), Climate systems India Ltd. (supra) and Munjal Showa Ltd. (supra) would also be applicable so as to arrive at the conclusion that the payment of running export commission paid as a percentage of export amount every year cannot be said to be capital expenditure. In view of the above, we delete the disallowance of export commission made by way of transfer pricing adjustment and also by way of general provisions of the Income-tax Act.
76. The next adjustment made by the Assessing Officer was with regard to payment of model fee. The assessee has paid a sum of `52,57,69,473/- by way of model fee to HMCL. The TPO determined the arm's length price only to the extent of 25% of the payment towards model fee. The conclusion of the TPO in paragraph 10.8 of his order reads as under:-
"10.8 In view of the fact that considerable money and effort is expended by the assessee, in indigenization of the technology, there is an 'economic ownership' of the trade intangible ('technology') which vests with the assessee to a far greater extent compared to the overseas AEs. In view of customization of the technology, right from the market research for the kind of technology that is required to be the R&D undertaken to given final shape to the production technology, the assessee is responsible for the development of technology. Hence, keeping in view the relative contribution of the parties involved in the development of the technology, I am of the considered view that the payment made by the assessee for model fee at the arm's length price should have been only to the extent of 25 percent of the payment towards model fee."
77. On appeal, the DRP also sustained the finding of the TPO with the following observation:-
71 ITA-5130/Del/2010 "Model fee was claimed to have been charged for making available technology for manufacture of newer models of the motorcycle and scooter in terms of technical knowhow agreement dated 02.06.2004 and supplementary amendment agreement dated 30.11.2004. The TPO observed that considerable amount of R&D expenditure is claimed in the Annual Account of the assessee and the assessee itself in the said annual account boasted of development and absorption of new technologies leading to introduction of new models, yet it is making payment of model fee without any regard to R&D carried out at its own end. The TPO after analyzing the matter and relying upon the OECD Guideline on transfer pricing of intra group services came to the conclusion because of considerable money and efforts undertaken by the assessee for indigenization of technology, the economic ownership of the trade intangible vests more with it rather than with HMCL. Hence the TPO held that 25% of the model fee paid should be the arm's length price in the given circumstances.
The assessee on the other hand emphasized the fact that technology of newer model of motorcycle with higher capacity and for the first time of scooter was provided to the assessee in lieu of model fee charged under agreement approved by the RBI. It contends that merely because some of the technology has been indigenized does not disentitle HMCL to receive model fee as contracted. The payment was wholly and exclusively for the purpose of business. The assessee emphasizes that it solely on the basis of technology provided by Honda, manufacture various models of motorcycles in India. The product manufactured conforms to the specification, drawing and design as provided by Honda. The assessee states that it does not undertake significant research and development activities, all of which are performed by Honda.
We have considered the arguments of the assessee and the stand taken by the TPO. In the Annual Report the assessee itself has mentioned about its research and development activities for new model technology absorption. It is mentioned that the R&D activity carried out by the assessee has resulted in to launching of new models in the current financial year. The assessee itself in its report has while claiming the expenditure on research 72 ITA-5130/Del/2010 and development publicized that benefit derived from research and development activities undertaken by it. On the one hand in its Annual Report the assessee itself declares that it has undertaken considerable R&D for launching of these model, on the other hand it states before the TPO and us that it did not undertaken significant research and development activities and all of them were undertaken by the Honda. No doubt technical design and specifications received from Honda helped the assessee in launching of new models, it is equally important not to undermine the contribution of the R&D carried out by the assessee leading to the launching of new models. In the context of this type of Intra group services, it is important to perform functional analysis and also to see that commensurate benefit has been accrued to the participating entities. OECD Guideline throws ample light on the key measures for applying arm's length test on such services as pointed out by the TPO. If we see that contribution of the assessee vis a vis the contribution of the AE in launching of new models, it is justified to treat 25% of model fee paid to HMCL as arm's length price commensurate to services rendered by it in launching of new models. As regards other issues like approval of RBI, use of methods, allowability u/s 37(1), discussion on these points in earlier paragraphs may be referred to.
In view of above, assessee's objection is not found tenable and ALP determined by the TPO is found to be correct. Hence, no interference in the draft assessment order on this issue is warranted."
78. At the time of hearing before us, it is stated by the learned counsel that the assessee is operating in a technologically intensive industry wherein continuous technological upgrading is imperative for the growth and survival of any industry. The assessee does not undertake any significant research for development of new model and is fully dependent upon HMCL for development of new model. HMCL is a global player and has strong research and development centre and has developed various types of products from time to time. The TPO has determined the arm's length price at 25% of the payment made by the assessee towards model fee on the ground that the assessee also 73 ITA-5130/Del/2010 contributed a lot in the development of the model. In this regard, he has referred that the assessee has undertaken market research and market study and has also incurred the expenditure on indigenization of the technology. Thus, as per the TPO, there was a significant contribution by the assessee in the development of the new model. He stated that the preliminary market research and market study was undertaken by the assessee so as to determine which type of the model is required by the assessee which would be most suitable in this country. Therefore, the market research made by the assessee was to ascertain the details about the model which it wanted the HMCL to develop for it. Thereafter, the entire activity of the research and development of the model was made by HMCL and there was no contribution by the assessee in such development of the model. The model development fee has been paid by the assessee for the development of the model by HMCL as per the specification of the assessee. The learned TPO as well as DRP has also referred to the assessee's audit report so as to point out that lot of research activity has been made by the assessee itself. That in the audit report, what is mentioned is that the assessee company has carried out research and development for new model technology absorption and indigenization of CKD parts etc. Thus, the research activity undertaken by the assessee was to absorb the technology of new model supplied by HMCL and to indigenization the parts of such model. That initially, whenever any new model is developed by HMCL, it is with the parts being manufactured by HMCL or its associated enterprises. However, such parts are costly and, therefore, gradually the assessee starts manufacturing the parts in India. The research activity undertaken by the assessee is for indigenization of such parts so that instead of importing the parts, the assessee can get them manufactured in India itself. Thus, the activity of the market research undertaken by the assessee was prior to the beginning of model development by HMCL 74 ITA-5130/Del/2010 and research activity undertaken by the assessee for technology absorption and indigenization of the part was subsequent to the development of the model and supply of the technical details of the new model developed by HMCL. The assessee has not at all helped HMCL in the research and development activity of the new model. The model development fee paid by the assessee is for research and development of the new model which is undertaken exclusively by HMCL. That in the earlier years, the Revenue has disallowed the model development fee paid by the assessee holding it to be capital expenditure. That first time the model development fee was disallowed as capital expenditure in AY 1996-97 but the ITAT allowed the assessee's appeal vide ITA No.3093/Del/2000. That on Revenue's appeal to the Hon'ble High Court vide ITA No.41/2006, the question of law was not admitted by the Hon'ble Jurisdictional High Court vide order dated 17th June, 2006. That again in AY 1999-2000, the same was disallowed as capital expenditure and the Assessing Officer held that on this model development fee, deduction under Section 35AB is allowable. On appeal, the ITAT, following its own order for AY 1996-97 in ITA Nos.5305 & 5511/Del/2003, held that the model development fee is allowable as a revenue expenditure. That on appeal to the High Court, the Hon'ble Jurisdictional High court did not admit any question of law on this point vide order dated 10.11.2008 in ITA No.610/2008. The Revenue's SLP was also dismissed by the Hon'ble Apex Court vide order dated 6.8.2010. He stated that since in the earlier years the effort of the Revenue to disallow model fee as a revenue expenditure failed up to Supreme Court, in this year, the Revenue adopted a different approach for disallowing the part of the model fee by way of transfer pricing adjustment. He stated that the disallowance of 75% of the model fee by way of transfer pricing adjustment is without any basis and in fact based on wrong facts. The TPO has not given any justification for benchmarking the model fee at only 25% of the actual 75 ITA-5130/Del/2010 model fee paid by the assessee. He has not applied any of the methods prescribed under the transfer pricing adjustment and just arbitrarily came to the conclusion that 25% of the model development fee paid by the assessee is the arm's length price. That in the Income- tax Act, various methods have been prescribed for determining the arm's length price and the CBDT in Instruction No.3/2003 dated 20th May, 2003 has provided that the arm's length price in relation to the international transaction has to be determined by any one of the methods stipulated in sub-section (1) of Section 92C. He also relied upon the following decisions :-
(i) CA Computer Associates Pvt.Ltd. Vs. DCIT - ITA Nos.5420 & 5421/Mum/2006.
He further stated that the above decision of Mumbai Bench of ITAT is approved by the Hon'ble Mumbai High Court in the case reported in 2012 (TII) 02 (HC).
(ii) Nimbus Communications Ltd. Vs. ACIT - ITA No.2361/Mum/2007.
79. He, therefore, stated that since the TPO has not determined the arm's length price by applying any of the methods prescribed under Section 92C(1) of the IT Act, the same cannot be adopted for making the addition in the case of the assessee. He further submitted that the payment of model fee was made after the approval of the Government of India. That the approval given to the assessee was not an automatic approval, on the other hand, the Ministry of Heavy Industries and Public Enterprises which is authorized to give approval, vide letter dated 26th April, 2005, mentioned that the lump sum payment for model development appears to be on higher side and, therefore, the assessee was required to furnish the detailed justification alongwith 76 ITA-5130/Del/2010 specification of the new models proposed to be manufactured. That the assessee furnished the detailed explanation vide letter dated 12th May, 2005 and thereafter, the approval was allowed vide letter dated 6th June, 2005. Thus, the quantum of the model fee paid by the assessee was found to be reasonable after appreciation of all facts by the Government of India, Ministry of Heavy Industries. Therefore, the arm's length price determined by the TPO without any basis or justification at 25% of the model fee paid by the assessee is incorrect and baseless. He further submitted that the assessee has adopted TNMM which is one of the prescribed methods under the Income-tax Act in respect of all the international transactions taken together for determining the arm's length price. While applying TNMM, the operating profit of the assessee was compared with the sales and operating profit ratio of the assessee to the sales was worked out at 16.03% which is much higher than the average of operating profit ratio of four comparable companies which was loss of 10.27%. Once TNMM is applied, it takes care of all the international transactions of the assessee. He further submitted that in the earlier years also, the assessee has made the payment for model fee because with the fierce competition in the business of manufacturing and sale of two wheelers, every year few new models are to be launched and therefore, almost every year, the assessee made the payment of model development fee. In all the preceding years, such model development fee paid by the assessee was accepted as reasonable and allowed. In few years, i.e. in AY 1996-97 and 1999-2000, it was disallowed holding it to be capital expenditure but was allowed by the Tribunal and the order of the Tribunal was sustained by the Hon'ble Jurisdictional High court as well as Hon'ble Apex Court. That in none of the earlier years, model development fee was held to be unreasonable and excessive. In view of the totality of facts, it is stated by the learned counsel that 75% disallowance of model development fee by determining the arm's 77 ITA-5130/Del/2010 length price as 25% is unjustified, illegal and without any basis and the same should be deleted.
80. The learned CIT-DR, on the other hand, relied upon the orders of the TPO, Assessing Officer as well as DRP. He stated that reference to the earlier years' orders of ITAT i.e. for AY 1996-97 and 1999-2000 is not relevant because in those years, the Revenue has disallowed the model development fee holding the same to be capital expenditure. While in the year under consideration the same was not disallowed as a capital expenditure, but the arm's length price has been determined by the TPO. He also submitted that the argument of the learned counsel that in the earlier year, the model development fee was held to be reasonable, would also not support the case of the assessee because - (i) in earlier year, there was no transfer pricing order and (ii) law of res judicata is not applicable to the income tax proceedings. He further submitted that the contention of the learned counsel that the payment of model development fee is approved by the Government of India is not relevant because that authority did not examine the payment from the angle of the transfer pricing provisions provided under the Income-tax Act. It is only the transfer pricing authorities who are competent to determine the arm's length price. In support of this contention, he relied upon the decision of Hon'ble Jurisdictional High Court in the case of CIT Vs. Nestle India Ltd. - 337 ITR 103 (Delhi). He further submitted that the development of new model was a joint activity undertaken by the assessee as well as HMCL. In fact, in the process of development of new model, more contribution was from the assessee's side than HMCL. The assessee first undertook the market research and market study and then give all inputs to HMCL. Then, even after the development of the model, again the assessee does further research and development so as to absorb the technology provided by HMCL. Thus, the contribution of the assessee in 78 ITA-5130/Del/2010 development of each model is much more than the contribution by HMCL and, therefore, the TPO has rightly determined the arm's length price at 25% of the model development fee paid by the assessee.
81. We have carefully considered the arguments of both the sides and perused the material placed before us. We find that the TPO has determined the arm's length price to the extent of 25% of the payment made towards model fee on the ground that it was a joint effort to develop the model and the contribution of the assessee right from the market research till the final shape of production was more than the associated enterprises. However, after considering the arguments of both the sides and the facts of the case, we are unable to agree with the above view of the TPO. The market research and market study incurred by the assessee was to ascertain what kind of model and technology was required by the assessee. Thereafter, the assessee requested HMCL to undertake research and development work for developing the kind of model required by the assessee. Thus, the market research and study by the assessee was prior to the beginning of research and development work by HMCL. The payment made by the assessee to HMCL was for the development of the model required by it. The market research and study was only to ascertain what kind of model was required by the assessee. Once HMCL has developed the model as per the specification of the assessee, it gave the complete technical information and knowledge with regard to that model to the assessee. Thereafter, research and development was carried out by the assessee for the absorption of technology of the new model and for indigenization of spare parts. Therefore, the role of the assessee was either prior to or subsequent to the development of model by HMCL as per the specification of the assessee. Thus, the presumption of the Assessing Officer that there was a joint activity for the development of the model and the model development fees also covered the activities 79 ITA-5130/Del/2010 undertaken by the assessee is factually incorrect. The model development fee is paid by the assessee to HMCL for the development of the model required by the assessee as per its specifications. The market research and market study was to ascertain which type of model was required by the assessee. Subsequent research and development by the assessee was for absorption of the technology and for indigenization of the parts. Even otherwise, there is no basis or justification for the TPO for arriving at the conclusion that the arm's length price for model fee should have been only to the extent of 25% of the payment made towards model fee. The TPO has not given any basis or justification for his conclusion that only 25% of the model fee paid by the assessee would be the arm's length price. He has not applied any of the methods prescribed under Section 92C(1) of the IT Act for determining the arm's length price.
82. It was pointed out by the learned counsel that for making the payment of model fee, the assessee required the permission of the Government of India. Before giving the permission, the Ministry of Heavy Industries examined the reasonableness of the model fee proposed to be paid by the assessee. In this regard, the learned counsel referred to the letter of Under Secretary to the Government of India, Ministry of Heavy Industries and Public Enterprises dated 26th April, 2005 which reads as under:-
"To M/s Hero Honda Motors Ltd., 34, Basant Lok, Vasant Vihar, New Delhi - 110 057.
Subject :- Approval for first supplementary amendment to License and Technical Assistance Agreement.
80 ITA-5130/Del/2010 Sir, I am directed to refer to your application No.HHML:TCA:SECT:VK:
ICK:05 dated 19.3.2005 on the subject cited above forwarded by Department of Industrial Policy and Promotion, PAB section to this Department, being Administrative Ministry for our comments.
2. While examining the proposal, it has been observed that the i.e. lumpsum payments asked for model (KTNA) JY 230,000,000, (KTPA) JY 500,000,000 & (KSTF) JY 310,000,000, appears to be on higher side. You are, therefore, requested to furnish the detailed justification along with specifications of the new models proposed to be manufactured as well as existing models and their technology comparison chart, to enable this Department to process the case further.
Yours faithfully, Sd/-
(M.R.BALI) Under Secretary to the Govt.of India Tel.No.23793823"
83. The assessee gave the reply vide letter dated 12th May, 2005 which reads as under:-
"HHML:TCA:SECT:VK-ICK:05: 12th May, 2005 Ministry of Heavy Industries & Public Enterprises Department of Heavy Industry Udyog Bhawan New Delhi-110011 Kind Attn : Mr. M.R.Bali Under Secretary to the Govt.of India Sub : Approval for first supplementary amendment to license and Technical Assistance Agreement.
81 ITA-5130/Del/2010 Dear Sir, This has reference to your letter No.3(23)/2004-AEI dated 26th April, 2005 asking for certain details regarding the proposal models and justification for the lump-sum payment thereof. In this connection, we wish to enclose herewith the detailed specification of each proposed model. You will appreciate that the technology which will be used in the proposed model is a new technology which is not available with the Company. One of the proposed model is scooter wherein the Company is not manufacturing scooter till date. The other model is a higher capacity motorcycle which is a new technology in itself. The 3rd model is a new model vis-a-vis for the compliance of new emission and environment norms. The details of technology, specification and other features are specified in the enclosure.
So far the amount of lump-sum payment is concerned we would like to inform you that Honda Motor Company Limited, Japan initially asked for 1630 Million Japanese Yen as lump-sum fee for these models which after a tedious negotiation of around an year was brought down to 1040 Million Japanese Yen. The first proposal was discussed sometime in the beginning of January, 2004 when Honda Motor Company Limited asked for 1630 Million Japanese Yen as lump-sum fee and 7% royalty on these models, towards the cost of their development. The Company had series of discussions and meetings with the representatives of Honda Motor Company Limited and ultimately in the end of November, 2004 a consensus was arrived wherein Honda Motor Co. Limited agreed to the proposed payment of Japanese Yen 1040 Million.
You will appreciate that, to meet the prevailing competition and the government regulation, the Company need to improve its existing models as well as introduce new models with additional and improved features which are in the benefit of customers and the Country. The Company want to give the value for money to its customers. For this purpose the Company has to take technology from its collaborators who in turn are putting a lot of efforts in development such product which are suitable for Indian conditions. They are spending lot of time and money on these development which they have to recover from the receiver of the technology i.e. Hero Honda Motors Ltd. You 82 ITA-5130/Del/2010 will appreciate that in commercial transaction the reasonable value is assessed by the parties depending upon the subject matter and prevailing circumstances and accordingly in this case also the parties have negotiated and settled for the proposed amount. You will further appreciate that the amount is well within the permissible limit prescribed by the Government for this purpose.
In view of the above we would be thankful if you kindly consider our proposal favorably and convey the approval of Govt. of India at your earliest.
Thanking you, Yours faithfully, For Hero Honda Motors Limited Sd/-
ILAM C.KAMBOJ Company Secretary"
84. Thereafter, the assessee was conveyed the approval of the Government of India vide letter dated 6th June, 2005 issued by the Ministry of Commerce & Industry, Department of Industrial Policy & Promotion. The same reads as under:-
"69(2004)/54(2004)/PAB-IL Government of India Ministry of Commerce & Industry Department of Industrial Policy & Promotion Secretariat for Industrial Assistance (PAB-IL Section) New Delhi the June 6, 2005 To M/s Hero Honda Motors Ltd.
34, Basant Lok, Vasant Vihar, New Delhi - 110 057.
Subject:- Application for amendment to the foreign technology collaboration *SIA Regn.No.54/SIA/FC/2004 dated 6.7.2004)
83 ITA-5130/Del/2010 Ref : This Ministry's FTC approval letter No.69(2004)/54(2004)/PAB-IL dated 6.9.2004.
Sir, I am directed to refer to your letter dated 19.3.2005 on the subject mentioned above and to convey the approval of the Government for inclusion of the following 3(three) new models of two wheelers in the existing collaboration agreement with M/s Honda Motor Co., Ltd., Japan on payments of royalty and model fee as mentioned under:-
(a) Royalty:-
(The rates/amounts are applicable to both 'domestic' and 'export' sales) Development code Model description Royalty rate
(i) KTNA CB1506/CB150M6 @ 4% for 3 years from the date of commencement of commercial production and @ 5% after the expiry of above three years.
(ii) KSTF (STD/DLX) CDN1005 @ 4% from the date of commencement of commercial production.
(iii) KTPA SCV100HH6 @ 4% for 3 years from the date of commencement of commercial production, and @ 5% after the expiry of three years period above.
The above royalty payment is subject to taxes, during the term of the "License and Technical Assistance Agreement".
(b) Lumpsum Payments (Model Fee for three (3) new models) Development code Model description Model Fee
(i) KTNA CB1506/CB150M6 JPY 230,000,000
(ii) KSTF CDN1005 JPY 310,000,000
(iii) KTPA SCV100HH6 JPY 500,000,000 84 ITA-5130/Del/2010 Total Model Fee of JPY 1,040,000,000 for the three new models mentioned above shall be paid in 3 instalments, subject to taxes.
2. All other terms and conditions of the letter dated 6.9.2004 referred to above shall remain unchanged.
3. Kindly acknowledge the receipt this letter.
Yours faithfully, Sd/-
(T.C.Sharma) Under Secretary to the Govt. of India Phone 23014088"
85. From the above letters, it is evident that before making the payment of model fee/royalty, the assessee had to seek the approval of the Government of India, Ministry of Commerce and Industry. However, the Ministry of Commerce and Industry, before giving permission, has sought for the comments of the Ministry of Heavy Industries and Public Enterprises. The Ministry of Heavy Industries examined in detail about the reasonableness of the payment and have directed the assessee to furnish the detailed justification for payment of lump sum model fee alongwith the specification of new models proposed to be manufactured as well as existing models and the technology comparison chart. In reply, the assessee gave detailed reply relating to all the three proposed models. It was pointed out that the first proposed model was scooter which was not being manufactured by the assessee company so far. The second model was a higher capacity motorcycle which was also a new technology. The third model was also a new model and was also to be modified for the compliance of new emission and environment norms. The details of technology, specification and other features were also submitted in the form of Annexure to this letter. In the second paragraph of the letter, the assessee also explained how the negotiation went on between HMCL and the assessee. After being satisfied with the explanation of 85 ITA-5130/Del/2010 the assessee about the reasonableness of the model fee, the Government of India, Ministry of Commerce & Industry gave permission for the payment of model fee.
86. The learned DR has argued that the approval by the Government of India is irrelevant because the permission of the approval by the government is totally different and the transfer pricing provisions are to be looked into by the TPO only. In support of this contention, he has relied upon the decision of Hon'ble Jurisdictional High Court in the case of Nestle India Ltd. (supra). The facts of the said case were that the assessee was engaged in the business of manufacture and marketing of various food products and beverages. In its return for the assessment year 1997-98, the assessee claimed deduction of the amount of `47,00,41,000 on account of royalty paid to its two subsidiary companies as business expenditure on account of technical assistance rendered by them to the assessee. The Assessing Officer formed the view that the payment made by way of commission/royalty was highly excessive in nature and there was no justification for making payment of this magnitude which was 40 per cent of the gross profits. The CIT(A) allowed the entire amount of royalty holding that royalty payment in terms of sales at 3.5 per cent to 5 per cent as against the Government norms of 5-8 per cent was reasonable. He further held that the royalty payments for technical know-how were linked to sales and not to profit which was a derived figure that could vary from year to year. The Tribunal held that the payment of commission was not huge or unreasonable and since it was a business expenditure the entire expenditure incurred by the assessee by way of payment of royalty/commission to the two overseas companies was entitled to deduction. On appeal, the Hon'ble Jurisdictional High Court dismissed the Revenue's appeal. However, with regard to the fact of 86 ITA-5130/Del/2010 permission given by the Reserve Bank of India, the observation of their Lordships at page 119 of the report reads as under:-
"We take up question of law No.2 in the first instance. We are of the view that the Tribunal is not correct in observing that since the permission is given by the Reserve Bank of India, the reasonableness and genuineness of the expenditure could not have been gone into by the Assessing Officer. The purpose for which such permission is given by the Reserve Bank of India is totally different. The Reserve Bank of India is only concerned with the foreign exchange and, therefore, would look into the matter from that point of view. The Reserve Bank of India, at the time of giving such permission would not keep in mind the provisions of the Income-tax Act and that is the function of the income-tax authorities and, therefore, they can validly go into such an issue. Thus, we answer question of law No.2 in favour of the Revenue and against the assessee but hasten to add that it has no bearing on the outcome of the case as the payment is found to be reasonable and genuine, even otherwise."
87. From the above, it is evident that merely because the permission is given by the RBI, the Assessing Officer is not debarred from looking into the reasonableness and genuineness of the expenditure. However, in the case under appeal before us, it is not the contention of the assessee that the TPO cannot consider or examine this aspect. His only submission was that the Government of India before giving the permission has examined the reasonableness of the payment and, therefore, the payment made by the assessee should be held to be reasonable and, therefore, at arm's length. We also find that the Hon'ble Jurisdictional High Court in the above case, while upholding the order of the ITAT on merits, observed at page 121 of the report as under:-
"It is stated at the cost of repetition that the Assessing Officer did not question the genuineness of the payment, namely, that the payment was in fact made by the 87 ITA-5130/Del/2010 assessee to the recipient foreign company/parent company. The assessee has been able to discharge its burden, namely, it was a justifiable and reasonable business expenditure and thus should be allowed under section 37 of the Act. We may recapitulate the following findings of the Tribunal in this behalf:
(i) that the assessee has successfully discharged this burden;
(ii) that the assessee has furnished almost the entire information asked for;
(iii) that technical assistance received by it was essential for its business purposes;
(iv) that the assessee highly benefited from this know-
how and technical assistance;
(v) that the quantum of remuneration was justified;
(vi) that the technical assistance was all pervasive in the operation of the assessee;
(vii) that there was no camouflage to siphon away Indian profits abroad; and hence disallowance of remuneration is not called for;
The Tribunal has held that the assessee having discharged the initial onus, the burden shifted to the Revenue to show that the payment of royalty was excessive or unreasonable having regard to the legitimate needs of business or that the assessee has made less than ordinary profits and the Revenue has not discharged the said onus."
88. In our opinion, the ratio of the above decision would be applicable to the facts of the assessee's case because in this case also, there is no dispute about the genuineness of the payment, namely, that the payment was in fact made by the assessee to the recipient foreign company. The assessee has furnished the entire information asked for by the AO/TPO. It is not even the allegation of the Revenue that any information is not furnished by the assessee. The technical 88 ITA-5130/Del/2010 assistance received by the assessee by way of development of new model was essential for the purpose of assessee's business. It is also not in dispute that the assessee was benefited from the know-how and technical assistance by way of model development by HMCL. The said technical assistance was all pervasive in the operation of the assessee's business.
89. Now, the only question remains whether the assessee has been able to discharge the initial onus to justify that the quantum of remuneration was reasonable. In our opinion, the assessee has been able to discharge the said onus - (i) by producing the copy of the correspondence between the assessee and the Government of India, Ministry of Heavy Industries by which it is evident that the Government has given approval only after examining in detail the reasonableness of the payment. In the letter dated 12.05.2005 written to the Ministry of Heavy Industries, the assessee has also specified how the negotiation took place between the assessee and HMCL and the model fee proposed to be paid by the assessee was arrived at after due negotiations between the assessee and HMCL. (ii) model development fee is being paid by the assessee since past many years and in none of the earlier years, it was held by the Revenue that the model development fee is excessive or unreasonable. In fact, in the earlier two years i.e. 1996-97 & 1999-2000, the expenditure by way of model development fee was treated as capital expenditure but the appellate authorities have held it to be revenue expenditure.
90. From the above, in our opinion, the assessee has duly discharged the initial onus which lay upon the assessee. Thereafter, the burden shifted to the Revenue to show that the payment of model development fee was excessive and unreasonable and therefore, arm's length price should have been less than what is actually paid by the 89 ITA-5130/Del/2010 assessee. We find that the TPO has not specified how the model development fee paid by the assessee was excessive or unreasonable. It is only his subjective assessment that the arm's length price of the model development fee should have been 25% of the payment made by the assessee. While taking this view, he has held that there was a joint activity of development of new model by the assessee and HMCL. The contribution of the assessee is much more than the HMCL and therefore, he attributed only 25% of the model development fee as arm's length price of the transaction. However, we have already discussed above that there was no such joint activity of the model development. The activity of the assessee of the market research and market study was for ascertaining the specifications of the model/technology required by it. Therefore, it was prior to the actual research and development undertaken by HMCL. The next activity of the assessee started only after the model is developed by HMCL and technology is handed over to the assessee. Then the assessee undertook the research and development activity for absorption of such technology and for indigenization of the spare parts. Thus, the activity of research and development of the model was undertaken by HMCL and not jointly by the assessee and HMCL. No other reason is given by the TPO for determining the arm's length price at 25% of the model fee paid by the assessee. He has not applied any method for determining the arm's length price prescribed under Section 92C(1) of the Income-tax Act. In view of the above, the decision of Hon'ble Jurisdictional High Court in the case of Nestle India Ltd. (supra) would support the case of the assessee rather than the Revenue. In view of the totality of above facts, we are unable to uphold the view of the TPO that the arm's length price of model development should be to the extent of 25% of the payment towards model fee. The same is set aside and the addition made on this count is accordingly directed to be deleted.
90 ITA-5130/Del/2010
91. The next issue is disallowance of royalty paid on exports made to associate enterprise amounting to `4,08,32,068/- by determining the arm's length price at nil.
The TPO made the disallowance with the following observations:-
"11.1 During the year under consideration the assessee has paid a royalty of Rs.212,40,40,877/- to the AE. It is seen from the details furnished and the agreements that the royalty has been paid on the Exports also. It has already been discussed that the exports have been made only to the AEs. This implies that the royalty has been paid on all the exports made to the AEs. The data furnished by the assessee shows that following payment of royalty has been done on the exports made to the AEs.
Models Export Quantity Royalty Rate Amount of Royalty
Ambition 24 781 18744
CBZ 8010 1653 13240530
CD 100 SS 32891 0 0
CD 100 SS DLX 757 916 693412
CD DAWN DLX 2721 741 2016261
Glamour 1878 940 1765320
Karizma 53 1324 70172
Passion Plus 14868 1042 15492456
Pleasure 15 1109 16635
Splendor Plus 19339 300 5801700
Super Splendor 2039 842 1716838
4,08,32,068
11.2 On analysis of the above facts following points are noticed:
1. The assessee is paying royalty to Honda Japan.
2. The exports are made to the subsidiaries or group companies of Honda Japan.
91 ITA-5130/Del/2010
3. The assessee, in a way is paying royalty to Honda Japan for the exports made to the subsidiaries and group companies of Honda Japan.
4. The assessee is also paying Export Commission to Honda Japan @ 5% for the exports made to the AEs.
5. In a way the price of exports made to AEs have been reduced by the amount of royalty and export commission as compared to the sale in the domestic market.
11.3 The position of the assessee company with regard to manufacturing for the AEs is that of a Contract Manufacturer. The assessee company is purchasing raw material from the AEs. The royalty paid as a percentage of sales to the associated enterprise is not at arm's length because it amounts to collecting royalty on the sales to itself. All the AEs are typically within the broad umbrella of the multinational corporation. Even though, it appears that the technical knowhow is commercially exploited in India, in realty the price for these activities are not fixed by market forces. Whether the sales of the assessee are made within India to its AE or to the parent company does not make much difference to the principles of arm's length transactions. In this case the capacity and other parameters are tied to the AE capacity and it cannot act like an entrepreneur. Therefore, both the risk and reward are like a contract manufacturer. No contract manufacturer would like to make this kind of transactions with an independent third party."
92. We have heard both the parties and perused the material placed before us. We have already considered similar issue while considering the disallowance of royalty and the export commission. While considering the disallowance of the export commission, we have noted that the payment of royalty and the export commission are for two different purposes. The assessee is paying royalty as per technical know-how agreement dated 02.06.2004 with HMCL. As per this agreement, the assessee is entitled to use technical know-how provided by HMCL for manufacture and sale of two wheelers and parts. Royalty is to be paid for the goods manufactured by the assessee, whether sold within India or outside India. It is not in dispute that the 92 ITA-5130/Del/2010 motorcycles which were exported by the assessee, were manufactured by using the technical know-how provided by HMCL under the technical know-how agreement dated 02.06.2004. Therefore, royalty is payable on such manufacturing of goods. The contention of the learned TPO that the goods are exported to subsidiaries of the Associate Enterprise i.e. AE of Honda Japan and the assessee also paid export commission, would be no ground for disallowance of the royalty or determining arm's length price of the royalty at nil. The assessee is exporting goods to AE of Honda on principal to principal basis and the price at which export is made is higher than the domestic price. While discussing the disallowance of export commission, we have discussed this issue at length and have noted that even after reducing the export commission, the assessee derived the benefit of `13.05 crores by export. At the cost of repetition, we would like to mention that the export sale value was more than the domestic sale rate and the assessee has given a detailed working thereof, which is enclosed with this order in the form of Annexure-I. In the above working, the assessee has reduced the export commission. Therefore, by export to the AE of Honda Japan, the assessee has been benefited and was not at a loss. The further finding of the TPO that the position of the assessee company with regard to export was that of a contract manufacturer, in our opinion, is without any basis and in fact contrary to the facts on record. The raw materials have been purchased by the assessee in its own right. It is not the case of the TPO that the raw materials have been supplied by the AE. The assessee has sold the goods to AE on principal to principal basis and has received the sale consideration. In view of the above, in our opinion, there is no justification for disallowance of the royalty on the export. We may reiterate that the Revenue has disallowed the entire royalty paid even on domestic sale which has been considered at length by us in the earlier paragraph of this order and we have arrived at the conclusion 93 ITA-5130/Del/2010 that the payment or royalty was a revenue expenditure, incurred for the purpose of business. Accordingly, the addition made by the TPO by determining arm's length price of royalty on export at nil is deleted.
93. The next addition is with regard to the purchase of raw material, spare parts and components. During the accounting year, relevant to the assessment year under consideration, the assessee made purchases of `81,10,78,331/- from its AE. The TPO determined the ALP at `79,56,73,801/-, which resulted in addition of `1,54,04,530/-. The relevant finding of the TPO in this regard reads as under:-
"12.7 The submissions of the assessee have been carefully considered. In his submissions, the argument of the assessee that the components/spares were imported from associated enterprises when it could not be supply by the local vendors is not acceptable because such an inability of the local vendors about supply of components/spares has not been demonstrated with material evidence and argument on this account are mere surmises and conjectures the assessee has not further disputed that the quality and performance of components purchased from domestic suppliers. Moreover, how the vendors have reacted to the continuous indigenization process vis-a-vis the capacity utilized has not been documented with credible figures. Further, there is no evidence on record to demonstrate that there exists any difference in the terms of payment to HMC and uncontrolled domestic suppliers. To eliminate the impact of difference in terms of delivery, the net of freight (F.O.B.) prices have been considered for comparison.
12.8 The assessee has not submitted any specific evidence to substantiate its argument that cost of production is higher in Japan. It has relied upon general arguments, e.g., higher per capita income in Japan, Big Mac Index is used by the assessee to justify this argument. It is true that wages are high in Japan but the productivity is also very high because of better mechanization, training, infrastructure etc. High productivity, to a very large extent, compensates for the higher wages. Therefore, this contention of assessee is not accepted. The assessee has
94 ITA-5130/Del/2010 made a passive observation that the steel prices are higher in Japan than India. This idea is not persuasive.
12.9 In view of the discussion above the conclusion is a clear conclusion that for benchmarking international transaction of import of spare/components the most appropriate method is Comparable Uncontrolled Price (CUP) method. The very fundamental facts that the components imported and purchased from domestic market are identical and there is no differentiation when these are use in the finished product that is motorcycle. It is not the case of the assessee that the motorcycle where imported component are used in any way different from the motorcycle where domestic component is used. There exists a highest degree of similarity between import and domestic purchase of the spares/components. It is very difficult to accept an argument that CUP is not applicable in such circumstances. The responsibilities to establish the arm's length nature of the international transactions lies with the assessee. The assessee failed to discharge this responsibility as the method relied upon by it is ot the most appropriate method for the reasons discussed above. Since the assessee has not brought out any difference in the quality of components purchased from HMC and from uncontrolled domestic suppliers, the ALP of imports from HMC, Japan can be determined by comparing it with the prices of uncontrolled domestic suppliers.
12.10 In this manner the ALP of the imports of various components from HMC, Japan and the adjustment arising out of difference between the ALP and the book price has been computed in the table given in Para 11.6 above. A perusal of this table reveals that there is different of Rs.1,54,04,530/- in the price as per book of account and arm's length price of the spare parts/components. In view of these finding, the arm's length price of purchase of spares/components reported in 3CEB needs a downward revision to the extent of Rs.1,54,04,530/-. Accordingly, the assessing officer shall increase the total income of the assessee by an amount of Rs.1,54,04,530/- while assessing its total income for the Assessment Year 2006-07 u/s 143(3) on account of adjustments in the ALP of international transaction for purchase of components of the assessee. The Assessing Officer may examine issue of initiation of penalty u/s 271(1)(c) of the Act in accordance with Explanation 7 of the same."
95 ITA-5130/Del/2010
94. The same is sustained by the DRP.
95. At the time of hearing before us, the learned counsel for the assessee argued at length and in addition, he also furnished synopsis of arguments, which reads as under:-
"The appellant is a manufacturer of two wheelers, viz., motor cycles under technical collaboration with HMCL. Motor cycles are manufactured by the appellant in India as per the technical specifications provided by the associated enterprises. The appellant it is submitted is governed by and is to adhere to the quality standard as laid down by the associated enterprises for manufacture of motorcycles in India.
The appellant had during the relevant previous year entered into, inter alia, the international transactions of purchase of spare and components aggregating to sum of Rs.81,10,78,331 from the associated enterprises as defined in sub-section (1) of section 92A of the Act.
The appellant in the TP documentation applied TNMM to determine the arm's length price of international transaction of import of components, spare parts, etc. It was also stated in the TP documentation that in absence of comparable uncontrolled price, CUP method cannot be applied to benchmark such transactions. The TPO, however, in his order applied CUP method by comparing the international transaction of import of components with prices of purchase of similar components after they are indigenized, from the domestic vendor.
The CUP method evaluates whether the amount charged in a controlled transaction is at arm's length with reference to the amount charged in a comparable uncontrolled transaction to provide a direct estimate of the price the parties would have agreed to, had they resorted directly to an open market alternative to the controlled transaction. Similarity of products in the controlled and uncontrolled transactions will have the greatest effort on comparability under this method. Minor differences in contractual terms or economic conditions could materially affect the amount
96 ITA-5130/Del/2010 charged in an uncontrolled transaction. The method becomes less reliable substitute for arm's length dealings if not all significant characteristics of the uncontrolled transactions are comparable. The prices of international transactions of import of components and spare parts would not be compared with the prices of such components sourced from local manufacturers in the domestic market after their indigenization. The appellant in absence of comparable uncontrolled transactions, has rightly applied Transactional Net Margin Method (TNMM) as the most appropriate method for determining the arm's length price of such international transactions.
Reliance is placed on the Hon'ble Mumbai Bench of the Tribunal in the case of Intervet India Pvt.Limited vs. ACIT :
ITA No.2845/Mum/2006, wherein it has been held that thetwo transactions between Thailand and Vietnam cannot be compared on account of economic and market conditions. Further, reliance may also be placed on the decision of the Hon'ble Mumbai Bench of the Tribunal in the case of Gharda Chemicals Ltd. vs. DCIT (ITA No.2242/Mum/06), wherein, the Hon'ble Tribunal held that location of parties to a transaction is a relevant criteria while evaluating the comparability of two transactions.
It is respectfully submitted that for manufacture of motorcycles, the appellant is required to source numerous components/spare parts as per the drawings/designs and specifications provided by the associated enterprises. The appellant continuously endeavours to indigenize such spares/components through development of suitable vendors/ancillaries in India. The indigenization of components, however, is a time consuming and critical process inasmuch as it requires developing capable vendor(s) having desired infrastructure and facility to produce the requisite components of the desired specification and quantity. In the initial stages of indigenization, there is high level of rejection before the production stabilizes and achieves acceptable quality norms. Further, the vendor(s) initially set up plant(s) with limited capacity, not commensurate with the requirement of the appellant, to avoid high risk and to first establish viability. Capacities are enhanced subsequently once business picks up and is profitable. For the aforesaid
97 ITA-5130/Del/2010 reasons, it is always difficult to have the full supply of the components from local vendor(s). In order not to disrupt the production process for want of required quality and quantity of components, the appellant had to perforce import of components from the associated enterprises, which was the only available source of supply. It is respectfully submitted that once the local vendor is able to fulfill the appellant's production requirements in the desired quantity and quality, the import of components is discontinued. It needs to be appreciated that the domestic vendor(s) had limited capacity to supply products/components, which fell short of the appellant's requirements. The associated enterprises, on the other hand, was in a position to cater to the appellant's complete requirement of such products/components.
The price paid to the local vendor(s), cannot, in such circumstances, it is respectfully submitted, be regarded as benchmark to determine the arm's length price for products imported from HM.
It is further submitted that the TPO erred in comparing the prices at which spares and components were purchased by the appellant from local vendors, to whom technology for manufacturing such parts and components was provided by the appellant, with the price at which the spares and components were purchased by the appellant from the associated enterprise, who is the owner of such technical know-how.
Reference may be invited in this regard to paragraphs 2.14 to 2.16 of the OECD guidelines. In the present case, prices of international transactions of import of components from associated enterprise in Japan, cannot be compared with domestic price of such components in much as purchase after indigenization for the reasons :
(i) The two transactions have been undertaken in entirely different economic and market scenario and are not comparable.
98 ITA-5130/Del/2010
(ii) There is geographical difference in the international transactions.
The TPO in the Transfer Pricing assessment for assessment year 2007-08 accepted the aforesaid contention of the appellant and did not make any adjustment on account of import of components."
96. The learned counsel also stated that in AY 2007-08, i.e. immediately succeeding year, under similar circumstances, the TPO accepted the assessee's argument and no addition was made. The order of the TPO is available at page 1900 of the assessee's paper book. He also submitted that the assessee made purchases of only `81 crores from AE out of the total purchases of `5,911 crores. This clearly proves the assessee's contention that the assessee made purchases from AE only when the spare parts/components were not available indigenously.
97. The learned DR, on the other hand, relied on the orders of the authorities below and stated that subsequent year's acceptance is not relevant for deciding the adjustment made in the year under consideration because the determination of ALP would depend on the facts of each year. He also submitted that for determining the ALP for purchase of spare parts/components, CUP method is the most suitable method and the TPO has rightly applied the same. He also stated that the assessee has contended that the purchases of spare parts were made from the AE only when the goods were not available indigenously, but, no evidence in support of the above contention was produced either before the TPO or before the Assessing Officer. The fact that TPO has considered the rate at which the spare parts were being purchased in India, clearly proves that such spare parts were available in India. He, therefore, submitted that the ALP determined by 99 ITA-5130/Del/2010 the TPO in respect of purchases of spare parts/components from the AE is quite justified, the same should be sustained.
98. In rejoinder, it is stated by the learned counsel for the assessee that before the TPO, the assessee has duly submitted that spare parts were purchased from AE only when the same were not available in India. If the TPO was not satisfied with this submission of the assessee and wanted evidence in this regard, he could have asked the assessee to produce the same. He further submitted that if an opportunity is given, the assessee is ready to produce the evidence either before the Assessing Officer or before the TPO as the Bench may direct.
99. We have carefully considered the arguments of both the sides and perused the material placed before us. After considering the facts of the case and the arguments of both sides, we agree with the Revenue that for determining the ALP of purchase of the spare parts/components, CUP method would be most appropriate method. Therefore, we uphold the selection of CUP method by the TPO. However, while applying the CUP method, it is to be ascertained whether similar goods were available indigenously. If the goods were not available indigenously, then naturally the rate of indigenous goods cannot be applied for determining the ALP. It is the contention of the assessee that when the goods were not available indigenously then only the same were purchased from AE. However, no evidence in this regard is produced by the assessee. At the same time, we find that no specific opportunity was allowed to the assessee to produce such evidence. In view of above, in our opinion, it would meet the ends of justice if the orders of authorities below on this point are set aside and the matter is restored to the file of the Assessing Officer. We order accordingly and direct the Assessing Officer to allow adequate opportunity to the assessee to produce evidence in support of its 100 ITA-5130/Del/2010 contention that the spare parts were purchased from the AE only when the same were not available indigenously. The Assessing Officer will readjudicate the issue in accordance with law after considering the submissions of the assessee and also after taking into account the order of the TPO for subsequent year, if the facts are similar.
100. In the result, the appeal of the assessee is partly allowed.
Decision pronounced in the open Court on 23rd November, 2012.
Sd/- Sd/-
(CHANDRA MOHAN GARG)
GARG) (G.D.AGRAWAL)
JUDICIAL MEMBER VICE PRESIDENT
Dated : 23.11.2012
VK.
Copy forwarded to: -
1. Appellant : M/s Hero MotoCorp Limited,
Limited,
34, Community Centre,
Basant Lok, Vasant Vihar,
New Delhi - 110 057.
2. Respondent : Additional Commissioner of Income Tax, Range-12, 3rd Floor, C.R.Building, Range-
I.P.Estate, New Delhi.
3. CIT
4. CIT(A)
5. DR, ITAT Assistant Registrar 101 ITA-5130/Del/2010