While upholding the order of ITAT, the division bench of the Delhi High Court held that royalty and technical assistance fee did not form part of a composite transaction and have to be treated as two separate transactions for the purpose of benchmarking and computing arms length price under the provisions of the Income Tax Act, 1961. While giving a partial relief to the appellant-assessee, while computing arm’s length price in respect of transaction relating to ”technical assistance fee, Transactional Net Margin Method can applied.
In the instant case, the assessee is a joint venture company engaged in the business of manufacture and sell Engine Control Units. While filing returns for the relevant assessment year, they reported six international transactions including “Payment of technical assistance fee” to the extent of `38,58,80,000/- .
The assessee, in terms with an agreement with its foreign Associated Enterprise (A.E.) acquired technology required for the purpose of manufacturing ECUs. applied the Transactional Net Margin Method (TNMM) to benchmark its international transactions of import of raw materials, sub-assemblies and components, payment of technical assistance fees, payment of royalty, payment of software and purchase of fixed assets. All these were categorized under one broad head, viz. “Manufacturing of automotive components”. The assessee claimed that its international transactions under the broad head (which included `Payment of technical assistance fee’) were the Arm‟s Length Price (ALP). While rejecting the submissions, the TPO observed that the Transactional Net Margin Method (“TNMM”) had to be applied separately for each international transaction and not collectively as done by the assessee. He, therefore, held all international transactions could not be ALP merely because the overall operating profit was more than the comparables. Consequently, assessees’ claim for “Payment of technical assistance fee” was also rejected. An assessment order was passed against the assessee accordingly.
The said order was challenged by the assessee before the Appellate Tribunal in which the Tribunal dismissed the appeal by holding that royalty and technical assistance fee did not form part of a composite transaction and have to be treated as two separate transactions for the purpose of benchmarking and computing arms length price. According to the Tribunal, Transactional Net Margin Method should not be applied for benchmarking/computing arm’s length price in respect of transaction relating to ”technical assistance fee.”Aggrieved with the above orders, the assessee approached the High Court.
the relevant provisions, i.e Sections 92, 92-C, 92-D and 92-E read together with Rule 10-B and 10-D indicate the approach of the TPO tasked with the obligation to discern, if in a given set of circumstances, the assessee has disclosed international transactions, as well as an ALP. The assessee has to –each year that international transactions are entered into with AE, file transfer pricing reports. These TP reports should be factually correct; and the assessee has to satisfy the queries of the TPO. Section 92-C underlines that the method appropriate to the transaction, amongst the four specified ones, is to be applied.
While rejecting the contentions of the assessee, the Court observed that “The initial burden is always upon the assessee to prove that the international transaction was at Arm‟s Length. Its TP report necessarily had to draw a comparison with other entities (maybe competitors) to show the general degree of profitability of the venture in question. The lower authorities quite correctly turned down the method of explaining the justification of the technical fee- with “proof” of its necessity by relying on profits. Undoubtedly the assessee was obliged to make the payment and that obligation arose from the agreements, a pre-incorporation binding contract. However, that such contractual obligation existed cannot ipso facto be the end of the enquiry. ALP determination in respect of every payment that is part of an international transaction is to be conducted irrespective of such obligation undertaken by the parties. If the transactions are, in the opinion of the TPO, not at arm’s length, the required adjustment has to be made, as provided in the Act, irrespective of the fact that the expenditure is allowable under other provisions of the Act. There can conceivably be various reasons not to subject such payments, such as for instance, if no similar data exists at all; or that sectional data for such payments is absent. Quite possibly, this may also be a general pattern of expenditure which AEs may insist to part with technology; further, similarly, other models of payment- deferred or lump sum, along with royalty or inclusive of it, may be discerned in comparable transactions. However, to say that such a substantial amount had to necessarily be paid and that it was a commercial decision, dictated by need for the technology, in the light of a specific query, it could not be said by the assessee that later profits justified it, or that has essentiality precluded the scrutiny.”
Regarding the second question, the Court accepted the method of TNMM applied by the assessee and opined that it is the most appropriate method in respect of all the international transactions including payment of royalty. “this court concurs with the assessee having accepted the TNMM as the most appropriate, it was not open to the TPO to subject only one element, i.e payment of technical assistance fee, to an entirely different (CUP) method. The adoption of a method as the most appropriate one assures the applicability of one standard or criteria to judge an international transaction by. Each method is a package in itself, as it were, containing the necessary elements that are to be used as filters to judge the soundness of the international transaction in an ALP fixing exercise. If this were to be disturbed, the end result would be distorted and within one ALP determination for a year, two or even five methods can be adopted. This would spell chaos and be detrimental to the interests of both the assessee and the revenue.”
Read the full text of the Judgment below.
