Income Tax Appellate Tribunal - Delhi
Lumax Industries Ltd., New Delhi vs Assessee on 17 July, 2012
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH : I : NEW DELHI
BEFORE SHRI G.D. AGRAWAL, HON'BLE VICE PRESIDENT
AND
SHRI A.D. JAIN, JUDICIAL MEMBER
ITA No.4456/Del/2012
Assessment Year : 2008-09
Lumax Industrues Ltd., Vs. ACIT,
B-85/86, Circle-4(1),
Mayapuri Industrial Area, New Delhi.
Phase-I,
New Delhi.
PAN : AAACL1126D
(Appellant) (Respondent)
Assessee by : Shri Pradeep Dinodia, Shri R.K.
Kapoor and Ms Pallavi Dinodia.
Revenue by : Shri Peeyush Jain, Sr. DR
ORDER
PER A.D. JAIN, JUDICIAL MEMBER
This is Assessee's appeal for Assessment Year 2008-09 against the order dated 17.07.2012 passed by the Assessing Officer, taking the following grounds:-
"1. That the learned Assessing Officer has erred in law and on facts in making an addition of Rs.8,03,58,167/- on wholly illegal, erroneous and untenable grounds.
2. The order of assessment is bad in law.
3. That the ld. A.O. has erred in law, on facts and in the circumstances of the case in making addition on account of arm's length price under section 92CA(3) of the Income Tax Act amounting to Rs.5,32,07,016/- on wholly illegal, erroneous and untenable grounds.2 ITA No.4456/Del/2012
4. The learned A.O's order based on the findings of the learned Transfer Pricing Officer and the directions of the learned Dispute Resolution Panel u/s 144C(5) of the Income-tax, is erroneous, untenable in law and on facts for the various reasons and not limited to the following:-
a) The TPO as well as the DRP and consequently the A.O. has passed in law and on facts and in the circumstances of the case in erroneously determining the ALP of the transaction on account of payment of royalty to the AE of the appellant as NIL.
b) The TPO as well as the DRP and consequently the A.O. has erred in law and on facts and in the circumstances of the case in erroneously holding that the appellant has not been able to show that it derived economic benefit from the know how received from the AE.
c) The TPO and DRP and consequently the A.O failed to appreciate that royalty was one of the two elements of cost and sales and could have been evaluated under same overall method as had been correctly done by the assessee under TNMM method and royalty payment is not independent of sales and could not be examined on stand alone basis.
d) The TPO as well as the DRP and consequently the A.O. has erred in law and on facts and in the circumstances of the case in erroneously exceeding their jurisdiction by judging the royalty payments made by the assessee through a benefit test, which is not based on not any of the method prescribed as per Section 92C of the IT Act.
5. The DRP as well as the A.O. has erred in law and facts and circumstances of case and made additions amounting to Rs.84,48,000/- on account of disallowance of provisions for warranty u/s 37(1) of the IT Act.
6. The DRP as well as A.O. has erred in law and facts and circumstances of the case and made additions amounting to Rs.1,75,26,309/- on account of disallowance of provisions for leave encashment u/s 43B of the IT Act.
7. The DRP and consequently A.O. has erred in law and facts and circumstances of the case and made additions amounting to Rs.11,26,737/- on account of disallowance u/s 14A of the IT Act r.w. Rule 8D of I Tax Rules.
8. That the adjustment made by the A.O. of Rs.50,105/- to the total income of the assessee on the ground of disallowance of depreciation on computer's peripherals @ 60% were erroneous, 3 ITA No.4456/Del/2012 factually incorrect, and not maintainable in law and is prayed not to be confirmed.
9. The DRP and consequently the A.O. have erred in law, on the facts and in the circumstances of the case in charging interest under section 234-B of Rs.1,30,70,415/- of the Income Tax Act, 1961 on wholly erroneous, illegal and untenable grounds.
10. The DRP and consequently the A.O. have erred in law, on the facts and in the circumstances of the case in charging interest under section 234C of Rs.13,68,438/- of the Income Tax Act, 1961 on wholly erroneous, illegal and untenable grounds.
11. The DRP and consequently the A.O. have erred in law, on the facts and in the circumstances of the case in charging interest under section 234D of Rs.1,08,400/- of the Income Tax Act, 1961 on wholly erroneous, illegal and untenable grounds."
2. As per the record, the business profile of the assessee company is as follows:-
"The appellant is a Public Limited and a listed Company incorporated under the Companies Act. The appellant had been engaged in the business of manufacturing and trading of lighting products for the automotive industries. The business of the appellant was set up in 1945 and expanded in 1957. Initially it was a partnership firm which was converted into a Pvt. Ltd. company in 1981 by the name of Lumax Industries Pvt. Ltd. The company was later on converted into a Public Ltd. company when it went public in 1984 and is now listed on both the NSE & BSE.
In 1984, the appellant entered into a technical collaboration agreement with Stanley Electric Co. of Japan, a global market leader in the same industry. The appellant had been manufacturing some of its products under the brand name of STANLEY for which it had been paying royalty after seeking necessary approval from SIA & RBI as was required at the relevant point of time. The approval accorded by RBI is continuing and is being renewed by RBI on a year to year basis. The royalty was initially being paid @ 4% on the sale of some of the products produced under the brand name of Stanley which later on was reduced to 3%.
Sometime in 1994, Stanley, Japan, acquired small equity stake in the appellant company and in the financial year 2003-04 (relevant to Asstt. Year 2004-05) this stake amounted to 19.41% of the total paid up capital of the appellant company. Stanley Japan also appointed an Executive Director on the Governing 4 ITA No.4456/Del/2012 Board of appellant and therefore by virtue of Section 92A (2) (e), it became an AE of the appellant. Similarly, the other 100% subsidiaries of Stanley Japan also became AE's of the appellant as per the definition of "associate enterprise" as contained in Section 92A (2) read with its various clauses."
3. Ground Nos.1 and 2 are general.
4. Apropos Ground No.3, the facts are that the assessee company filed its return for the year under consideration, declaring income of ` 17,81,88,750/-. This return was processed u/s 143 (1), on 12.09.2009. A draft assessment order u/s 144C of the IT Act was served on the assessee. The assessee filed its objections before the DRP on 26.12.2011. The said objections were disposed of by the DRP vide Order dated 14.06.2012. The final assessment order was passed on 17.07.2012. The present appeal has been preferred thereagainst.
5. The TPO, vide Order dated 30.10.2011, passed u/s 92CA (3) of the Act, suggested upward assessment of assessee's income by `5,32,07,016/-, observing as follows:-
" In the present case the taxpayer has benchmarked the transaction related to payment of royalty under CUP. Hence, the CUP taken by the taxpayer is not acceptable for the reasons discussed above. But as discussed in the preceding paras, the taxpayer has failed to furnish certain vital information like how the royalty rate was determined along with basis thereof, what cost benefit analysis was done, what is the royalty rate paid by other AEs or independent persons, what is the industry rate, what is the cost incurred by the AE for developing the intangible, what was the expected benefit from the use of the intangible, etc. Such information was essential to benchmark the transaction. As held by the ITAT in the case of Aztech Software (supra) it is the duty of taxpayer to furnish complete information not only about the transactions entered into by it with the AE, but also about the comparable cases, as the assessee is in that field and has knowledge about the comparables also. The ITAT further held that if the taxpayer does not furnish such information, the TPO would be justified in determining the arm's length price on the basis of the information available with him. For some of the questions, the taxpayer has simply stated that it is not privy to the information related to the AE. As held by the ITAT, Mumbai in the case of UCB India (2009-TII-02-ITAT-Mum-TP), it is 5 ITA No.4456/Del/2012 the duty of the AE to furnish requisite information to the taxpayer, if it wants to help the assessee in its tax matters. If the AE does not provide the relevant information, then it is not for the revenue to conclude in the subsidiary's favour. On the question of benefit derived from the use of the intangible, the taxpayer could have at least done the analysis by following the income approach viz. discounted cash flow method to show as to what was the excepted benefit from the use of the intangible. The taxpayer has not taken pains to do the aforesaid.
I am therefore, left with no other alternative but to benchmark the transaction by applying the 'benefit test' which is an internationally accepted method. Under this test it is to be seen as to whether the taxpayer has received any tangible benefit from the use of the intangible which would help it in earning greater economic benefit. In arm's length situation a person would pay royalty only if the use of the technology will give him greater economic benefit. In the present case, as discussed above, despite the use of the intangible the margin of the assessee is lower than the comparables. This clearly shows that the technology has not provided any benefit to the assessee. No independent person in such a situation will pay any royalty. This view is also supported by the ITAT, Delhi's decision in the case of Abhishek Auto (2010-TII-54-ITAT-DEL-TP) wherein the ITAT held as under:-
"If the tested party without the use of imported technology and imported raw material can make additional margins, then it would be case the international transactions have demonstratively boosted the profits of the appellant."
In view of the above discussion and particularly keeping in view of the fact that the assessee has neither benchmarked this transaction property by applying the most appropriate method and nor has it furnished the requisite information I am constrained to determine the arm's length price of this transaction at NIL under CUP method. No independent person in similar circumstances would pay any such royalty.
I am aware of the ITAT, Delhi's decision in the case of Ekla Appliances (2011-TII-37-ITAT-DEL-TP). However, the aforesaid decision is not applicable as in that case it was found that the technology had helped the taxpayer in reducing its losses significantly. It was also found that there were peculiar reasons for incurring the losses. Thus, the aforesaid decision is of no help. Similarly, the decision of ITAT, Hyderabad in the case of LG Polymers is of no help as in that case the transaction was treated as sham and the matter was restored to the file of the AO/TPO for fresh determination of the ALP.
Thus, the arm's length price of royalty is determined at Rs. NIL.
a. Payment of Royalty Rs.5,32,07,016/-
b. Arm's length price under CUP Rs.NIL
c. Adjustment u/s 92CA Rs.5,32,07,016/-
6 ITA No.4456/Del/2012
The above amount of Rs.5,32,07,016/- is treated as adjustments under section 92CA as the value of royalty transactions in uncontrolled conditions is treated as Rs. NIL under CUP and the absence of any substantiation to show that substantial benefit is accrued to the taxpayer."
6. The assessee made detailed submissions before the Assessing Officer. The Assessing Officer, however, did not find the same to be acceptable and an addition of ` 532,07,016/- was made to the total income of the assessee. While doing so, it was observed as follows:-
"The proposed enhancement of Rs.5,32,07,016/- was brought to the notice of the assessee vide order sheet entry dated 08.11.2011. The submissions of the assessee company have been duly examined, considered and however, not found acceptable. On the basis of TPO's order under section 92CA(3) dated 30.10.2011, an addition of Rs.5,32,07,016/- is made to the total income of the assessee. The order passed by the Transfer Pricing Officer under section 92CA(3) is annexed herewith and made a part of this assessment order.
The assessee filed its objections before the Hon'ble Dispute Resolution Panel - I, New Delhi. The Hon'ble Dispute Resolution Panel - I, New Delhi vide order dated 14.06.2012 held that the conclusion of the TPO was correct and declined to interfere with the proposed adjustments.
I am satisfied that the assessee filed inaccurate particulars of its income and thereby concealed its income to the tune of Rs.5,32,07,016/-. Penalty proceedings under section 271(1)(c) are initiated separately for furnishing inaccurate particulars of income."
7. Before us, it has been contended on behalf of the assessee that the ALP of the transaction of the assessee on account of payment of royalty to its AE has wrongly been determined by the authorities below; that it has wrongly been held that the assessee was not able to show that it had derived economic benefit from the know-how received by it from its AE; that it has not been appreciated that the royalty was one of the two elements of cost and sales and could have been evaluated under the same overall method, as correctly done by the assessee under the TNMM; that it has not been appreciated that the royalty payment was not independent of sales and could not have 7 ITA No.4456/Del/2012 been examined on a standalone basis; that it was not correct to judge the royalty payment on the yardstick of the benefit test, the same not being based on any of the methods prescribed u/s 92C of the IT Act; that it has wrongly not been taken into consideration that it was since 1984, that the assessee was in association with Stanley Electric, Japan; that the assessee's relationship with Stanley Electric, Japan turned into that of an AE in 1994; that it has not been appreciated that royalty payment was being made by the assessee to Stanley Electric, Japan, right from 1984 and this continued even after Stanley Electric, Japan acquired the status of an AE of the assessee; that it has not been appreciated that in 1984, the assessee was a small company, having a turnover of just about ` 2 crores, whereas in the year under consideration, it had evolved into a company having a turnover of ` 600 crores; that no justification has been given as to how the arm's length price has been determined at nil under the CUP method, as against that of ` 5.32 crores claimed by the assessee, notwithstanding the fact that the TPO himself noted that the royalty had been paid by the assessee to its AE @ 3%; that 3% stands accepted as the rate of payment of royalty in the cases of the following companies:-
1. Sona Okegawa Precision Forgings Ltd.
2. Federal Mogul TPR India Ltd.
3. Climate Systems India Ltd.
4. Eicher Motors Ltd.
5. Swaraj Engines Ltd.
6. Praga Tools Ltd.
7.1 That the decisions in this regard are as follows:-
1. 'Sona Okegawa Precision Forgings Ltd. vs. ACIT' (ITA No.4781/Del/2010) 8 ITA No.4456/Del/2012
2. 'ACIT vs. Sona Okegawa Precision Forgings Ltd.' (ITA No.260/Del/2010.
3. 'CIT vs. Federal Mogul TPR India Ltd.' (ITA No.398/2012)
4. 'Climate Systems India Ltd. vs. CIT' (2009) 319 ITR 113 (Delhi)
5. 'CIT vs. Eicher Motors Ltd.' (2007) 293 ITR 464 (MP)
6. 'Praga Tools Ltd. vs. CIT' (1980) 123 ITR 773 (A&P);
that the assessee also being an auto ancillary and, therefore, part of the automotive industry, is clearly comparable in its payment of royalty to the royalty paid, as accepted to be at arm's length, in the aforesaid cases @ 3%; that in all the aforesaid cases, the royalty is related to transfer of technical assistance and know how in the automotive industry; that the technical collaboration agreement of the assessee (copy at APB-I, pages 340-359), which is duly approved by the Government of India, has not been taken into consideration by the authorities below; that the AE of the assessee is paying 40% tax in Japan and so, the observation of the TPO to the effect that there is siphoning off profit from India with minimum incidence of tax, is wrong; that the assessee is paying 30% tax in India; that in the balance sheet for the years ended on 31.03.2008 and 31.03.2007 of assessee's AE (copy at APB-I, page 403), royalty income has been shown; that in the assessee's AE's Note to Consolidated Financial Statements (APB-I, page 412), the expenditure for the year under consideration has been shown at 47 million US $, whereas the income is of 10 million US $, i.e., much less; that this goes to show that if the assessee's AE had filed a return on the royalty under consideration in India, there would have been a loss; that this aspect of the matter has also not been taken into consideration; that further, it is wrong to state that no economic benefit accrued to the assessee vis-a-vis the payment of royalty, since the royalty was paid only in respect of the Japanese customer, i.e., on 9 ITA No.4456/Del/2012 43% sale; that as available from APB-I, page 385, i.e., the total of royalty paid by the assessee to its AE, for the period from 1.4.07 to 31.3.08, the royalty is about 2.43% of the net sales of ` 2180871964.63; and that the TPO did not deem it fit to do any benchmarking qua the issue of royalty, i.e., no comparable was brought. Besides the case laws mentioned hereinabove, the ld. counsel for the assessee has sought to place reliance on 'KHS Machinery (P) Ltd. vs. ITO', 53 SOT 100 (Ahm.), wherein, it has been, inter alia, held that where the Assessing Officer had not brought on record the ordinary profits which could be earned in the type of business carried on by the assessee, the finding of the Assessing Officer in considering royalty charges as nil as ALP, could not be accepted and that therefore, the payment of royalty was not hit by the provisions of Section 92-C of the Act.
8. On the other hand, the Ld. DR has strongly supported the orders of the authorities below. It has been contended that just because the assessee and its AE are public listed companies, the requirement of establishment of arm's length price cannot be left uncomplied; and that apropos the RBI approval of 3% to 4% of payment of royalty, the assessee did not benchmark its payment of royalty. The Ld. DR has placed reliance on the following case laws:-
8.1 Order dated 30.3.2012 passed by the Mumbai Bench of the Tribunal in ITA No.5979/Mum/2010 and CO No.130/Mum/2011 for Assessment Year 2005-06, in the case of CMA CGM Global India (P) Ltd., wherein, according to the Ld. DR, earlier payment made to the same party, i.e., when the party was not an AE of the assessee, was not allowed. The Ld. DR has submitted that therefore, for payment made to an AE, there has to be a separate benchmarking, even if earlier payments had been made to the same party. The Ld. DR has 10 ITA No.4456/Del/2012 further contended that there is no CUP available for royalty payments and that the CUP method has been applied by the assessee relying on the RBI approval granted to it, which is of no value, since the RBI approval is for the purposes of FEMA/FERA and not a deterrent debarring the taxing authorities from going into the transaction of payment of royalty. The following case laws have been relied on:-
a) 'Delloite Consulting'
b) 'Nestle India', 337 ITR 102 (Del)
c) 'Interra'
d) 'Aztec' (107 ITD 141)
e) 'Knorr Bremse'
f) 'CMA CGM Global India Pvt. Ltd.'
9. The Ld. DR has further contended that the assessee's contention regarding allowance of the payment u/s 37 of the Act is not at all maintainable, since the Assessing Officer and the TPO were in entirely different situations; that Section 37 of the Act and the Proviso to Section 92 thereof operate in entirely different fields. Reliance has again been sought to be placed on 'Deloitte' (supra).
10. The Ld. DR has further contended that the propositions of law sought to be raised by the assessee are not maintainable before the Tribunal, since they impinge upon the aspect of constitutionality. The decision in 'Interra' (supra) has been relied on.
11. So far as regards the commercial expediency aspect, the Ld. DR has stated that it is true that the Income-tax Authorities cannot dictate to the assessee as to how its business is to be carried on, but he facts in the present case are in pari materia with 'Knorr Bremse' (supra), wherein also, the assessee had incurred losses.11 ITA No.4456/Del/2012
12. Addressing the issue as to whether nil ALP could have been allowable, the Ld. DR has submitted that there may be a benefit, but it cannot be a passive and incidental benefit - it has to be a tangible benefit. Here, he places reliance on 'Knorr Bremse' (supra) and 'Delloite' (supra).
13. On the issue of consistency, the Ld. DR has contended that it is well settled that a mistake cannot be allowed to be perpetuated; that if in the earlier years, a claim had been mishappenly accepted, such a mistake cannot bind the Department forever; that moreover, in the earlier cases, the payment was considered u/s 37 of the Act and not u/s 92C thereof. Reliance has been sought to be placed on CBDT Circular No.12 of 23.08.2001 (copy placed on record).
14. The Ld. DR has further contended that even otherwise, the royalty should be separately benchmarked, as there is a chance of cross-subsidisation. He further contended that in the present case, there is no intangible involved and the assessee sells products under the brand name 'Lumax' and not 'Stanley.'
15. We have heard both the parties on this ground and have examined the material placed on record with regard thereto. The issue is as to whether the addition of ` 532,07,016/- on account of arm's length price, has correctly been made concerning the payment of royalty by the assessee to its AE.
16. The TPO proposed the enhancement of ` 532,07,016/- to the total income of the assessee company on the basis that the assessee had failed to furnish information as to how the rate of royalty payment was determined, the basis thereof, the cost benefit analysis done by 12 ITA No.4456/Del/2012 the assessee, the royalty rate paid by other AEs or independent persons, the industry rate of payment of royalty, the cost incurred by the AE for developing the intangible, the expected benefit from the use of the intangible, etc. The TPO observed that such information was essential to benchmark the transaction. It was also observed that regarding the issue of benefit derived from the use of the intangible, the assessee did not show as to what was such expected benefit and that therefore, the transaction had to be benchmarked by applying the benefit test; that in the assessee's case, in spite of the use of the intangible, the margin of the assessee was lower than the comparables, which clearly showed that the technology had not provided any benefit to the assessee; and that no independent person in such a situation would pay any royalty.
17. The Assessing Officer made the addition on the basis of the aforesaid findings of the TPO. The DRP declined to interfere with the said proposed adjustment.
18. Therefore, the main reason, rather the only reason recorded by the authorities below for disallowing the royalty payment is that of the alleged inability of the assessee to satisfy the 'benefit test'. In other words, the royalty payment made by the assessee company was disallowed for the alleged inability of the assessee to quantify the benefit which it had obtained from such payment of royalty.
19. In this regard, it is seen that during the year, royalty was paid by the Assessee to its AE on sales made using the trade mark of 'Stanley';
that the assessee is a widely held listed company, a market leader. The payment of royalty was for trade mark, patent and technology. The contract, i.e., the Technical Collaboration Agreement, between the assessee and its AE stood approved by the Government since 1984.
13 ITA No.4456/Del/2012Ever since, the assessee had been carrying out the manufacture of some of its products under the brand name of 'Stanley.' For this, the assessee had been paying royalty. Approval in this regard had been pre-obtained from SIA, as required. The RBI had also granted its approval, which was being renewed yearly. Initially, the royalty had been paid @ 4% on the sale of some of the products produced under the brand name 'Stanley.' Later, it was reduced to 3%. In F.Y. 2003- 04, Stanley Electric Company of Japan acquired the status of the AE of the assessee. Thus, it was right from 1984, that technical assistance got started being given by Stanley Electric Company, Japan to the assessee, with regard to the manufacture of automotive lighting equipment. As available from para 1.4 of the agreement in the year under consideration (copy at APB-I, 340-359, relevant portion at page
342), a non-exclusive licence had been granted by Stanley, Japan to the assessee, only for India. As per the conditions thereof, the assessee was to pay royalty on its net sales, after deduction from the net sale price of the licensed products sold by Lumax in India. The basis of calculation of payment of royalty, as agreed to, is contained in Article 4 of the Agreement (APB-I, page 345). Such payment was to be @ 4% on the net sales. However, during the year, royalty was paid @ 2.43% on the sale of licensed products, amounting to ` 218.08 crores, as available at APB-I, page 385. This was so, since the cost of standard imported components, standard local components and certain other deductions had been deducted from the net sales of ` 218.08 crores.
20. The Ld. DR has contended that just because the assessee and its AE are publicly listed companies, this is no reason for the requirements of ALP to be flouted. However, the assessee's contention regarding both the entities being listed companies, it is seen, is not at all to support any violation of the ALP provisions. This argument, in fact, has 14 ITA No.4456/Del/2012 been taken to bolster the assertion regarding benefits of the transactions and the genuineness thereof.
21. The next contention of the Department has been that the RBI approval sought to be relied on by the assessee is only for the purposes of FEMA/FERA and it does not stop the transaction from being looked into by the Income-tax Authorities for the purpose of the Income-tax Act. Here again, it is seen that this argument has been taken by the Assessee only to stress that the agreement between the assessee and Stanley was not merely a paper transaction, rather it was approved by the RBI as well, besides other governmental authorities. It has not been shown by the Department to be otherwise.
22. The Ld. DR then contended that the royalty in question was not benchmarked by the assessee, as held by the TPO and that it has not been shown that the payment of royalty was an arm's length transaction. Since the average PLI of the comparables taken by him resulting in 7.05% - OP/sales was within the (+)/(-) 5% range of the assessee's PLI worked out by him at 4.09%, the range between 2.05% to 12.05%, as per the proviso to Section 92C (2) (2A) of the Act.
23. The Ld. DR has further contended that the assessee did not apply the CUP method properly, since such method has been supported by the assessee, based on the approval by the RBI. In this regard, we find that as noted above, the argument regarding the RBI approval was raised by the assessee to buttress the claim of genuineness of its transaction. In the TPO's order, there is not even as much as a mention about RBI. So far as regards the DR's objection that the plea of earlier payment to the same party, when it was not the assessee's AE, has not been allowed, is not maintainable, it is to be reiterated here, as above, that the assessee did benchmark its 15 ITA No.4456/Del/2012 transaction by two methods, i.e., CUP and TNMM and this was taken note of by the TPO himself. Apropos the reliance by the Department on 'CGM Global' (supra), it is correct that therein, the internal CUP was held to be not applicable, since the transaction was with an AE having related party transactions and it was held that there was no external CUP for making any comparison in the relevant year, as the earlier Agency Agreement with the third party had expired and rates applicable in the earlier years could not be made applicable during the relevant year. However, this decision does not have any adverse effect on the case of the assessee. The facts herein are entirely at variance with those of 'CGM Global'. Herein, as opposed to the facts in 'CGM Global', the same Royalty Agreement and the same licence has been in continuance from 1984 till the year under consideration, the licence being renewed from year to year, albeit on the same terms and conditions. Moreover, the following decisions are instances of the external CUP having been employed and this has not been disputed by the Department:-
1. 'Sona Okegawa Precision Forgings Ltd. vs. ACIT' (ITA No.4781/Del/2010)
2. 'ACIT vs. Sona Okegawa Precision Forgings Ltd.' (ITA No.260/Del/2010.
3. 'CIT vs. Federal Mogul TPR India Ltd.' (ITA No.398/2012)
4. 'Climate Systems India Ltd. vs. CIT' (2009) 319 ITR 113 (Delhi)
5. 'CIT vs. Eicher Motors Ltd.' (2007) 293 ITR 464 (MP)
6. 'Praga Tools Ltd. vs. CIT' (1980) 123 ITR 773 (A&P)
7. 'Ekla Appliances (2012-TII-01-HC-DEL-TP)
8. 'Ericsson India Pvt. Ltd. vs. DCIT' (2012-TII-48-ITAT-Del-TP) 16 ITA No.4456/Del/2012
24. In ''Sona Okegawa Precision Forgings Ltd.' (supra), it has been held that since the royalty paid by the Indian company was 3% of net sales and it falls within the range of @ 8% on export sales and 5% on domestic sales as per directions of the RBI, therefore, the payment stands justified under the CUP method.
25. This view was accepted by the Tribunal in 'Sona Okegawa's case for Assessment Year 2004-05 also, as well as in 'Climate Systems' (supra), 'Swaraj Engines Ltd.' (supra) and 'Eicher Motors' (supra).
26. In 'Federal Mogul' (supra), payment of royalty @3% on the sale price, on transfer of technical knowledge and information, was accepted.
27. In 'Climate Systems India Ltd.' (supra), again, payment of royalty @ 3% on the sale price on transfer of technical knowledge and information was accepted.
28. All the above companies, like the assessee, were in the auto ancillary industry.
29. In 'Praga Tools Ltd.' (supra), which was also in an auto ancillary industry, payment of royalty @ 5% on the sale price, on transfer of technical know how and assistance was accepted.
30. The royalty payment by the above companies is directly comparable with that made by the assessee company. The assessee, as observed, is also an auto ancillary, manufacturing automotive parts for OEMs. In all these cases, as in that of the assessee, the payment of royalty was related to transfer of technical assistance and know-how in 17 ITA No.4456/Del/2012 the automotive industry. That being so, the CUP method is available apropos the issue of arm's length price qua the payment of royalty.
31. So far as regards other case laws relied on by the Department, the same are also distinguishable on facts, being on general propositions of law relevant to the specific facts present in those cases. In the present case, an ALP analysis had been done by the assessee, as above. The assessee applied the CUP method and the TNMM. The TPO, however, despite being legally bound to do so, did not apply any method.
32. Apropos the decision of the Delhi Bench of the Tribunal in the case of 'Interra Information Technology (I) Pvt. Ltd. vs. DCIT', 2012- TIOL-142-ITAT-DEL-TP (supra), it is seen that here also, the facts are at a complete variance with those of the assessee's case, wherein payment of royalty for supply of technology and knowhow to manufacture licensed products was held to be for the benefit of the assessee and the same rate of royalty payment was allowed as allowed in the years when the parties were not in an AE relationship, but were having identical transactions as those in the year under consideration before the Tribunal. It was held that the royalty payment was a revenue expenditure incurred wholly and exclusively for the benefit of the assessee. The part of the payment disallowed as capital expenditure was held by the Hon'ble Delhi High Court to be revenue expenditure. It is as such that the invocation of the rule of consistency has been sought on behalf of the assessee and, in our considered opinion correctly so, contending that since the circumstances before and after the coming into existence of the AE relationship between the assessee and Stanley are identical inter se, it cannot at all be said that though in the earlier years, the royalty payment was for the benefit of the assessee, since the inception of the AE relationship, it ceased to be 18 ITA No.4456/Del/2012 so, due to which, the application of the benefit test by the TPO is entirely uncalled for. Payment of royalty was being claimed and allowed right from 1984 to Assessment Year 2003-04, as business expenditure of the assessee and no new circumstance has been pointed out by either of the authorities below to hold that in the years thereafter, the benefit accrued to the assessee by the payment of such royalty has dried up. Therefore, we find that the reliance by the Department on 'Interra' (supra), to support the contention that the rule of consistency should not be applied, is wholly misplaced. It cannot be gainsaid that a judgement has to be, in its entirety, considered in the backdrop of and with reference to the peculiar facts and circumstances doing the rounds therein. In 'Interra' (supra), the assessee raised an argument that transfer pricing adjustment at best cannot exceed the amount of the margin retained by the assessee as well as the AE. This argument did not find favour with the Tribunal. It was also contended that the TPO had not made any adjustment in the earlier years and as such, no adjustment was called for in the year before the Tribunal as well, on the principle of consistency. The Tribunal observed that the assessee had not been able to demonstrate as to which particular conclusion of the previous TPO or Assessing Officer had been reviewed in an opposite manner by the current TPO and that it was a case of non-application of mind by the previous TPO on some issues. It was therefore, that the Tribunal rejected this argument raised by the assessee. This is the background for the Tribunal not having allowed the principle of consistency to be invoked in that case. In the present case, however, it is patent on record that the facts remain identical pre-AE relationship and thereafter, as also that the related payment has been consistently allowed by the department itself in the numerous earlier years, where the arguments were at an exactly similar, nay identical footing.
19 ITA No.4456/Del/201233. The TPO has made the disallowance in question mainly on the basis of the benefit test. In this regard, it is seen that the payment of royalty cannot be examined divorced from the production and sales. Royalty is inextricably linked with these activities. In the absence of production and sale of products, there would be no question arising regarding payment of any royalty. Rule 10A(d) of the ITAT Rules defines 'transaction' as a number of closely linked transactions. Royalty, then, is a transaction closely linked with production and sales. It cannot be segregated from these activities of an enterprise, being embedded therein. That being so, royalty cannot be considered and examined in isolation on a standalone basis. Royalty is to be calculated on a specified agreed basis, on determining the net sales which, in the present case, are required to be determined after excluding the amounts of standard bought out components, etc., since such net sales do not stand recorded by the assessee in its books of account. Therefore, it is our considered opinion that the assessee was correct in employing an overall TNMM for examining the royalty. The TPO worked out the difference in the PLI of the outside party (the assessee) at 4.09% and the comparables at 7.05%. This has not been shown to fall outside the permissible range.
34. The decision of the Tribunal in 'Ekla Appliances', 2012-TII-01-HC- Del-TP, has been sought to be distinguished by the TPO, observing that the facts in that case are not in pari materia with those of the assessee's case. However, therein also, the benefit test had been applied by the TPO, as in the present case. The matter was carried in appeal before the Hon'ble High Court. The Hon'ble Delhi High Court has held that the so-called benefit test cannot be applied to determine the ALP of royalty payment at nil and that the TPO could apply only one of the methods prescribed under the law. A similar view has been 20 ITA No.4456/Del/2012 taken in 'Sona Okegawa Precision Forgings Ltd.' (supra) and in 'KHS Machinery Pvt. Ltd. vs. ITO', 53 SOT 100 (Ahm) (URO).
35. It is, thus, seen that the royalty payment @ 3% by the assessee is at arm's length. The Technical Collaboration Agreement stands approved by the Government of India. The royalty payment has been accepted by the department as having been made by the assessee wholly and exclusively for its business purposes. For Assessment Years 2004-05 and 2005-06, such payment of royalty has been allowed by the CIT (A). As per the FEMA Regulations, royalty can be paid on net sales @ 5% on domestic sales and @ 8% on export sales. The royalty payment by the assessee falls within these limits. It also falls within the limits of payment of royalty in the automobile sector, as per the market trend. This payment of royalty is at the same percentage as that paid by other auto ancillaries in the automotive industry. Then, in 'Ekla Appliances' (supra) and in 'Ericsson India Pvt. Ltd. vs. DCIT', 2012-TII-48-ITAT-Del-TP, it has been held that royalty payment cannot be disallowed on the basis of the so-called benefit test and the domain of the TPO is only to examine as to whether the payment based on the agreement adheres to the arm's length principle or not. That being so, the action of the TPO in the present case, to make the disallowance mainly on the ground of the benefit test, is unsustainable in law.
36. Keeping in view all the above factors, the disallowance made on account of royalty is found to be totally uncalled for and it is deleted as such. Accordingly, ground Nos.3 and 4 raised by the assessee are accepted.
37. Coming to ground No.5, the assessee contends that addition of ` 84,48,000/- on account of disallowance of provisions of warranty u/s 37(1) of the Act has wrongly been made and confirmed. The Assessing 21 ITA No.4456/Del/2012 Officer noted from Form No.3CD that the assessee had made provision for warranty. The assessee was asked to show cause as to why the same be not disallowed, as it was a contingent liability. The assessee submitted that during the year, it had worked out the amount of net warranty liability by applying a multiplying factor on the total sales made during the year on the basis of past results and had made provisions in its books; that since the provision had been made based on the past factor of actual expenses incurred towards warranty liability, deduction claimed with regard thereto u/s 37(1) of the Act was an allowable expenditure. Reliance was placed on the Tribunal decision in the case of 'DCIT, Circle 4 (1) vs. LG Electronics (I) Ltd.' and the Hon'ble Supreme Court decision in the case of 'Rotork Controls India Pvt. Ltd. vs. CIT', 314 ITR 62 (SC), beside other case laws. The Assessing Officer, however, observed that in the case laws referred to by the assessee, the crucial findings were that the claim of the assessee should be on a scientific basis and the assessee should have been regularly following this system of accounting for warranty; that however, in the assessee's case this system of accounting for warranty had been introduced only in F.Y. 2005-06; that thus, it could not be said that the assessee had been regularly employing this method over a number of financial years; and that further, the multiplying factor determined by the assessee for working out the warranty provision could not be said to be a scientific method for determination of the provision of warranty, being based on a single year data base. The Assessing Officer held that the provision for warranty amounting to ` 1,61,61,410/- was liable to be disallowed, but an amount of ` 77,73,410/- stood disallowed in the earlier years and, therefore, a net amount of ` 84,48,000/- was being disallowed and added back to the total income of the assessee company. The DRP upheld this action of the Assessing Officer.
22 ITA No.4456/Del/201238. Challenging the action of the Assessing Officer, the ld. counsel for the assessee has contended before us that while wrongly making the disallowance, the Assessing Officer has failed to take into consideration the fact that the provision was made by the assessee on a highly scientific basis, based on actual warranty expenses incurred by the assessee for the unexpired warranty period. Reliance has been placed on 'Rotork Controls India Pvt. Ltd.' (supra) and 'CIT vs. Becton Dickinson', 2012-TIOL-962-HC-Del-IT. It has been contended that similar provisions for warranty have not been disallowed in the earlier years, upto Assessment Year 2005-06. A chart in this regard has been filed.
39. The Ld. DR, on the other hand, has placed strong reliance on the impugned order in this regard.
40. In this regard, it is seen that the Assessing Officer made the disallowance on the basis that the provision for warranty was a contingent liability, having no scientific basis. Indeed, undisputedly, the assessee was making the provisions on actual warranty basis for the unexpired warranty period, providing warranty of one year on the products which it was selling. It created provision for warranty for the unexpired period of warranty as at the end of the year, on a percentage of the actual warranty expenses during the immediately prior period, on the sales made. It has not been shown as to how this basis of making provision for warranty is not scientific. Moreover, similar provision for warranty was not disallowed in the earlier years, upto Assessment Year 2005-06. This position is also supported by the Hon'ble Supreme Court's decision in 'Rotork Controls India Pvt. Ltd.' (supra) and the Hon'ble Delhi High Court decision in 'Becton Dickinson' (supra). Accordingly, this addition is deleted and ground No.5 is allowed.
23 ITA No.4456/Del/201241. Apropos ground No.6, the assessee has challenged the addition of ` 1,75,26,309/- made on account of disallowance of provisions for leave encashment u/s 43B of the Act.
42. The Assessing Officer observed that the assessee's provisions for leave encashment had increased to ` 3,27,47,739/-. The assessee had maintained that the deduction had been claimed in view of the decision of the Hon'ble Calcutta High Court in the case of 'Exide Industries vs. UOI', 292 ITR 470 (Cal). The Assessing Officer asked the assessee to show cause as to why the amount be not disallowed and added back to the assessee's total income, since the decision in 'Exide Industries' (supra) had been stayed by the Hon'ble Supreme Court. The assessee submitted that during the year, it had made provision for leave encashment amounting to ` 1,75,26,309/- as per the actuarial valuation, in compliance of AS-15 of the ICAI and had claimed it as a business expenditure. The Assessing Officer, however, made the disallowance. The DRP upheld the Assessing Officer's action.
43. The assessee's challenge to the action of the Assessing Officer has been on the stated basis that there has been a double addition, since the assessee had itself made the disallowance and the amount had not been taken to the Profit & Loss Account at all. It has been pointed out that the Tribunal also, in the Stay Order granted in favour of the assessee, has observed that there has been a double addition in this regard.
44. The Ld. DR, on the other hand, has placed strong reliance on the impugned order.
24 ITA No.4456/Del/201245. As to whether there has indeed been a double addition, needs to be verified by the Assessing Officer by confirming as to whether or not the assessee had made the disallowance itself and the amount had not been carried to the Profit & Loss Account. For this purpose, the matter is remitted to the file of the Assessing Officer, to be decided afresh in accordance with the law, on affording adequate and due opportunity to the assessee. Ground No.6 is, as such, treated as allowed, for statistical purposes.
46. Ground No.7 states that the addition of ` 11,26,737/- on account of disallowance u/s 14A of the Act read with Rule 8D of the IT Rules has wrongly been made.
47. The assessee was found to have made investment, income wherefrom, according to the Assessing Officer, did not form part of the assessee's taxable income. The disallowance was made, observing that separate bank accounts had not been maintained by the assessee in respect of investments and other activities; that there was a common pool of funds and it could not be ascertained whether the investments had been made out of internal accruals or from borrowed funds; that had the assessee company not made the investments, its total borrowings would have been lower, leading to reduction in interest costs; that the assessee had not attributed any administrative expenses towards the earning of exempt income; that the interest expenses of ` 4,92,95,768/- were not directly attributable to any particular income or receipt; and that by maintaining such investments and other investment related activities, administrative expenses were attributable to them. Accordingly, the Assessing Officer made the following disallowance u/s 14A of the Act read with Rule 8D of the IT Rules:-
25 ITA No.4456/Del/2012S.No. Disallowance Amount (Rs.)
1. The amount of expenditure directly relating to 0
income which does not form part of total
income
2. In a case where the assessee has incurred A=4,92,95,768/-
expenditure by way of interest during the B=25,22,01,525/-
previous year which is not directly attributable C=345,18,91,509/-
to any particular income or receipt, an amount
computed in accordance with the following Hence, disallowance
formula - = 36,01,639/-
AXB/C
Where
A = amount of expenditure by way of
interest other than the amount of interest
included in clause (1) incurred during the
previous year.
B = the average of value of investment,
income from which does not or shall not form
part of the total income appearing in the
balance sheet of the assessee, on the last day
and the last day of the previous year.
C = the average value of total assets as
appearing in the balance sheet of the assessee
on the first day and the last day of the previous
year.
3. An amount equal to on-half per cent of the 1/2 % of average
average of the value of investment, income investment of
from which does not or shall not form part of Rs.25,22,01,525/-
the total income, as appearing in the balance = 12,61,008/-
sheet of the assessee, on the first day and the
last day of the previous year
Total disallowance Rs.48,62,647/-
Less disallowance made by the assessee in Rs.12,61,008/-
computation of income
Balance net disallowance Rs.36,01,639/-
48. Thus, an amount of ` 36,01,639/- was proposed to be disallowed. However, the DRP held that the interest of ` 3,38,74,081/- was to be excluded while calculating the disallowance. As such, the disallowance was recomputed as follows:-
26 ITA No.4456/Del/2012S.No. Disallowance Amount (Rs.)
1. The amount of expenditure directly relating to 0 income which does not form part of total income
2. In a case where the assessee has incurred A=4,92,95,768/-
expenditure by way of interest during the minus previous year which is not directly Rs.3,38,74,081/- (as attributable to any particular income or per the directions of receipt, an amount computed in accordance the Hon'ble DRP) = with the following formula - Rs.1,54,21,687/-
AXB/C B=25,22,01,525/-
Where C=345,18,91,509/-
A = amount of expenditure by way of
interest other than the amount of interest Hence, disallowance
included in clause (1) incurred during the = 11,26,737/-
previous year.
B = the average of value of investment,
income from which does not or shall not form
part of the total income appearing in the
balance sheet of the assessee, on the last day
and the last day of the previous year.
C = the average value of total assets
as appearing in the balance sheet of the
assessee on the first day and the last day of
the previous year.
3. An amount equal to on-half per cent of the ½ % of average
average of the value of investment, income investment of
from which does not or shall not form part of Rs.25,22,01,525/-
the total income, as appearing in the balance = 12,61,008/-
sheet of the assessee, on the first day and
the last day of the previous year
Total disallowance Rs.48,62,647/-
Less disallowance made by the assessee in Rs.12,61,008/-
computation of income
Balance net disallowance Rs.11,26,737/-
49. As such, the disallowance u/s 14A of the Act read with Rule 8D of the Rules came to ` 11,26,737/-, which amount was added back to the total income of the assessee company.
50. The ld. counsel for the assessee has contended before us that the assessee had itself worked out a disallowance of ` 12,61,008/-; that however, neither the Assessing Officer, nor the DRP adjudicated on the aspect as to how such disallowance made by the assessee itself was 27 ITA No.4456/Del/2012 incorrect or not acceptable; that the assessee is a manufacturing concern and its entire infrastructure is meant for manufacturing activities; that the assessee company has a turnover of about ` 508 crores from its manufacturing operations; that the Assessing Officer attributed interest cost under Rule 8D of the Rules, overlooking the fact that the assessee was having huge funds of its own and investments were made out of these funds only; that it was also overlooked that the borrowings had been made for specific purposes of working capital and other business operations, due to which, no interest cost was attributable to the earning of dividend income; that it had been specifically stated before the DRP also, that investment of ` 43.72 crores during the year had been made out of capital receipt of ` 56 crores. Reference in this regard has been made to page 478 of the assessee's paper book. Attention has also been drawn to the assessee's balance sheet (APB-31) to show that the assessee's investments went up to ` 46.99 crores from ` 3.44 crores and its capital and reserves increased to ` 143.35 crores from ` 81.46 crores; and that the loan refunds had decreased from ` 97.38 crores to ` 82.84 crores, establishing that no borrowed funds had been utilized.
51. The Ld. DR has placed strong reliance on the impugned order.
52. Here also, we find that the matter needs verification by the Assessing Officer, for which purpose, it is remitted to the file of the Assessing Officer. The Assessing Officer shall re-adjudicate the matter in accordance with law on affording adequate opportunity to the assessee, particularly verifying the aforesaid averments made by the assessee.
53. As per ground No.8, the adjustment made by the Assessing Officer, of ` 50,105/- to the total income of the assessee on the ground 28 ITA No.4456/Del/2012 of disallowance of depreciation on computer peripherals @ 60%, is erroneous.
54. The Assessing Officer, it is seen, restricted the depreciation on computer peripherals to 15% as against @ 60%, as claimed by the assessee. The matter, as rightly contended, is covered in favour of the assessee by 'BSES Yamuna Power Ltd.', 2010-TIOL-636-HC-Del. No decision to the contrary has been brought to our notice. Therefore, in view of this decision of the jurisdictional High Court, this issue is decided in favour of the assessee, accepting ground No.8.
55. Ground Nos. 9-11 concern charging of interest under sections 234B to 234D of the IT Act, amounting to ` 1,30,70,415, ` 13,68,438/- and ` 1,08,400/-, respectively. These issues are consequential in nature.
56. In the result, the appeal of the assessee is partly allowed, as indicated.
The order pronounced in the open court on 31.05.2013.
Sd/- Sd/-
[G.D. AGRAWAL] [A.D. JAIN]
VICE PRESIDENT JUDICIAL MEMBER
Dated, 31.05.2012.
dk
29 ITA No.4456/Del/2012
Copy forwarded to: -
1. Appellant
2. Respondent
3. CIT
4. CIT(A)
5. DR, ITAT
TRUE COPY
By Order,
Deputy Registrar,
ITAT, Delhi Benches