SC Enviro Agro India Ltd. v. Dy. CIT

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The Tax Publishers2013 TaxPub(DT) 1927 (Mum-Trib) : (2013) 053 (II) ITCL 0143 : (2013) 143 ITD 0195 Income Tax Act, 1961 --Transfer pricing--computation of ALP Royalty payment--Assessee-company was engaged in manufacturing of household insecticides in crop protection field and entered into a non-exclusive technical licence agreement with SCCL for commercial production of specified products. SCCL acquired 90 per cent of equity shares of company. As per agreement, assessee-company had to sell its products only to parties approved by said SCCL. Assessee company agreed to pay royalty at the rate of 5 per cent, to SSCL. One of the companies to which most of the products were sold was a 100% subsidiary of SCCL. In the transfer pricing report, assessee submitted that the arrangement with SCCL and SCI was in the nature of contract manufacturing. The transactions were referred to TPO for determining Arms length Price. TPO, however, examined the payment of royalty at 5% to SCCL as per technology licence agreement. He was of the opinion that since the purchases and sales are only from/to associate concerns and also on the reason that sales are not to be made to anybody else. He considered that functions being performed by assessee was nothing but contract manufacturing. Since it is a contract manufacturing agreement, there is no justification for payment of royalty for use of technical know-how, etc. Accordingly, he determined the arm's length price at NIL and disallowed an amount paid by assessee to M/s SCCL as royalty. *Held:* Not justified. Transfer pricing Rules do not authorize TPO to disallow any expenditure on ground that it was not necessary or prudent for assessee to have incurred same. As such, royalty paid to SCCL was wholly and exclusively for purpose of business and hence was therefore, allowable. Assessee entered into an agreement for obtaining license to manufacture specified insecticides and pesticides and agreed to pay 5% royalty on the value addition and RBI has approved the royalty at 5% for a period of seven years. Till assessment year 2003-04 there was no dispute with reference to the payment of royalty and even in the original assessment completed the royalty was allowed as eligible expenditure in the order under section 143(3). In assessment year 2004-05, this issue for the first time was examined by the TPO on the basis of the TP report of assessee wherein assessee submitted that the arrangement is in the nature of contract manufacturers in the FAR analysis. Since this was admitted by assessee, the TPO without examining the nature of agreement or the manufacturing activity of assessee or any other incidental factor came to a conclusion that since assessee admitted to be a contract manufacturer, there is no need to pay any royalty. In his order, the TPO also mentioned that assessee was not making any sales to outside parties, the fact of which is not correct. On the basis of his observations, he arrived at the royalty arm's length price at Nil. [Para 11] The TPO has done in the present case is also to hold that assessee need not pay any royalty on the presumption that assessee is a contract manufacturer. The TPO has to examine whether the price paid or amount paid was at arms length or not under the provisions of Transfer Pricing and its rules. The rule does not authorize the TPO to disallow any expenditure on the ground that it was not necessary or prudent for assessee to have incurred the same. On that principle alone, Tribunal cannot approve the order of the TPO as it not only considered the facts wrongly but also exceeded the jurisdiction available to the TPO in examining the arm's length price on a transaction. [Para 13] Apart from the legal position stated above, even on merits the disallowance of entire royalty payment on sales to AE was not warranted. Assessee admitted that it wrongly claimed in the TP report that the arrangement is in the nature of contract manufacturing. However, as seen from the agreement entered by the erstwhile Home Remedies Ltd with SCCL it is for obtaining license for manufacturing specified products. Since the technology is specific to the manufacturing specific items, the condition is that the intermediates are to be imported from the SCCL. However, after importing the intermediates assessee is also-using the indigenous material in manufacturing the specified insecticides and pesticides. It is also acquiring packing material required for packing insecticides and pesticides produced in 5 litres and 20 litres containers. Since these insecticides and pesticides are for specified usage (mosquito repellents, etc.,) these products are mainly sold to AE and also to other third parties who require the insecticides and pesticides so manufactured. Assessee is also paying excise duty and other taxes. The principal company is not paying any amount to the assessee company towards manufacturing if it were to be considered as contract manufacturing. Even though admittedly assessee mentioned in the TP report that the arrangement is in the nature of contract manufacturing, the facts indicates otherwise. The royalty was paid as per the agreement on the value-added price to the SCCL for providing the license and technical know-how. This payment is independent of whether assessee is full fledged manufacturer or a contract manufacturer or a toll manufacturer and the nature of manufacturing activity cannot have any bearing on the payment of royalty. As submitted, the royalty is not paid on the entire sales price but only on the value added price which was worked out separately. Tribunal is also surprised that the Commissioner (Appeals) restricted the royalty on the sales to AE only when the sales to AE was at arms length price as that of sales to third parties. There is no logic in allowing the sales made to the third parties and not on sales made to AE. As already stated the said agreement was approved by the RBI for payment of royalty at 5% for a period of 7 years. There was also no such disallowance in earlier years. Since Tribunal does not find any reason to restrict the royalty to Nil, Tribunal is not in a position to approve the order of the Commissioner (Appeals) on this issue. Without going into the nitty-gritty of determining whether assessee is a contract manufacturer or a full-fledged manufacturer, since royalty is paid for allowing assessee in utilizing the technical know-how and the license for manufacturing activity, the payment of royalty is wholly and exclusively for the purpose of business. In view of this, Tribunal allow assessee's ground and directs assessing officer to allow the royalty as claimed. [Para 14] Assessee also raised one of the arguments as ground that the TP adjustment so made will be within the safe harbor limit of +5%. This argument cannot be accepted as the International Transaction is the payment of royalty alone. The TPO determined ALP at NIL which works out to 100% variation. This is more than the safe harbor limit prescribed. Therefore, this argument cannot be accepted. However, Tribunal has held that the payment of royalty is wholly and necessarily for the purpose of business. [Para 15] The rate of royalty at 5% was allowed by Commissioner (Appeals) on part of sales. Revenue has not come in appeal or objected to the said rate. Therefore, 5% royalty rate is at arm's length price. For all the reasons stated above, assessee's payment of royalty cannot be disallowed invoking the TP provisions. assessing officer is directed to allow the same. [Para 16] SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2013 TaxPub(DT) 1927 (Mum-Trib) : (2013) 053 (II) ITCL 0143 : (2013) 143 ITD 0195

Income Tax Act, 1961

--Transfer pricing--computation of ALP Royalty payment--Assessee-company was engaged in manufacturing of household insecticides in crop protection field and entered into a non-exclusive technical licence agreement with SCCL for commercial production of specified products. SCCL acquired 90 per cent of equity shares of company. As per agreement, assessee-company had to sell its products only to parties approved by said SCCL. Assessee company agreed to pay royalty at the rate of 5 per cent, to SSCL. One of the companies to which most of the products were sold was a 100% subsidiary of SCCL. In the transfer pricing report, assessee submitted that the arrangement with SCCL and SCI was in the nature of contract manufacturing. The transactions were referred to TPO for determining Arms length Price. TPO, however, examined the payment of royalty at 5% to SCCL as per technology licence agreement. He was of the opinion that since the purchases and sales are only from/to associate concerns and also on the reason that sales are not to be made to anybody else. He considered that functions being performed by assessee was nothing but contract manufacturing. Since it is a contract manufacturing agreement, there is no justification for payment of royalty for use of technical know-how, etc. Accordingly, he determined the arm's length price at NIL and disallowed an amount paid by assessee to M/s SCCL as royalty. Held: Not justified. Transfer pricing Rules do not authorize TPO to disallow any expenditure on ground that it was not necessary or prudent for assessee to have incurred same. As such, royalty paid to SCCL was wholly and exclusively for purpose of business and hence was therefore, allowable.

Assessee entered into an agreement for obtaining license to manufacture specified insecticides and pesticides and agreed to pay 5% royalty on the value addition and RBI has approved the royalty at 5% for a period of seven years. Till assessment year 2003-04 there was no dispute with reference to the payment of royalty and even in the original assessment completed the royalty was allowed as eligible expenditure in the order under section 143(3). In assessment year 2004-05, this issue for the first time was examined by the TPO on the basis of the TP report of assessee wherein assessee submitted that the arrangement is in the nature of contract manufacturers in the FAR analysis. Since this was admitted by assessee, the TPO without examining the nature of agreement or the manufacturing activity of assessee or any other incidental factor came to a conclusion that since assessee admitted to be a contract manufacturer, there is no need to pay any royalty. In his order, the TPO also mentioned that assessee was not making any sales to outside parties, the fact of which is not correct. On the basis of his observations, he arrived at the royalty arm's length price at Nil. [Para 11] The TPO has done in the present case is also to hold that assessee need not pay any royalty on the presumption that assessee is a contract manufacturer. The TPO has to examine whether the price paid or amount paid was at arms length or not under the provisions of Transfer Pricing and its rules. The rule does not authorize the TPO to disallow any expenditure on the ground that it was not necessary or prudent for assessee to have incurred the same. On that principle alone, Tribunal cannot approve the order of the TPO as it not only considered the facts wrongly but also exceeded the jurisdiction available to the TPO in examining the arm's length price on a transaction. [Para 13] Apart from the legal position stated above, even on merits the disallowance of entire royalty payment on sales to AE was not warranted. Assessee admitted that it wrongly claimed in the TP report that the arrangement is in the nature of contract manufacturing. However, as seen from the agreement entered by the erstwhile Home Remedies Ltd with SCCL it is for obtaining license for manufacturing specified products. Since the technology is specific to the manufacturing specific items, the condition is that the intermediates are to be imported from the SCCL. However, after importing the intermediates assessee is also-using the indigenous material in manufacturing the specified insecticides and pesticides. It is also acquiring packing material required for packing insecticides and pesticides produced in 5 litres and 20 litres containers. Since these insecticides and pesticides are for specified usage (mosquito repellents, etc.,) these products are mainly sold to AE and also to other third parties who require the insecticides and pesticides so manufactured. Assessee is also paying excise duty and other taxes. The principal company is not paying any amount to the assessee company towards manufacturing if it were to be considered as contract manufacturing. Even though admittedly assessee mentioned in the TP report that the arrangement is in the nature of contract manufacturing, the facts indicates otherwise. The royalty was paid as per the agreement on the value-added price to the SCCL for providing the license and technical know-how. This payment is independent of whether assessee is full fledged manufacturer or a contract manufacturer or a toll manufacturer and the nature of manufacturing activity cannot have any bearing on the payment of royalty. As submitted, the royalty is not paid on the entire sales price but only on the value added price which was worked out separately. Tribunal is also surprised that the Commissioner (Appeals) restricted the royalty on the sales to AE only when the sales to AE was at arms length price as that of sales to third parties. There is no logic in allowing the sales made to the third parties and not on sales made to AE. As already stated the said agreement was approved by the RBI for payment of royalty at 5% for a period of 7 years. There was also no such disallowance in earlier years. Since Tribunal does not find any reason to restrict the royalty to Nil, Tribunal is not in a position to approve the order of the Commissioner (Appeals) on this issue. Without going into the nitty-gritty of determining whether assessee is a contract manufacturer or a full-fledged manufacturer, since royalty is paid for allowing assessee in utilizing the technical know-how and the license for manufacturing activity, the payment of royalty is wholly and exclusively for the purpose of business. In view of this, Tribunal allow assessee's ground and directs assessing officer to allow the royalty as claimed. [Para 14] Assessee also raised one of the arguments as ground that the TP adjustment so made will be within the safe harbor limit of +5%. This argument cannot be accepted as the International Transaction is the payment of royalty alone. The TPO determined ALP at NIL which works out to 100% variation. This is more than the safe harbor limit prescribed. Therefore, this argument cannot be accepted. However, Tribunal has held that the payment of royalty is wholly and necessarily for the purpose of business. [Para 15] The rate of royalty at 5% was allowed by Commissioner (Appeals) on part of sales. Revenue has not come in appeal or objected to the said rate. Therefore, 5% royalty rate is at arm's length price. For all the reasons stated above, assessee's payment of royalty cannot be disallowed invoking the TP provisions. assessing officer is directed to allow the same. [Para 16]