Transfer Pricing – TPO should provide reasons for rejecting the Most Appropriate Method [MAM] used by the assessee before adopting a different MAM

Indian Additives Limited Vs The ACIT (ITAT Chennai)- Fact that a particular MAM used by the taxpayer cannot be rejected without providing any cogent reasons. Further, the Tribunal has mentioned that if there exist significant amount of purchases from Associates enterprises , the same cannot be included while computing the gross margins under the Resale Price Method [RPM]. The Tribunal have also re-emphasised the importance of comparing the FAR analysis of the tested party and that of the comparable companies while applying the TNM method.

ITAT Chennai

I.T.A. No. 703/Mds/2009

Assessment Year : 2004- 05

Indian Additives Limited Vs The Assistant Commissioner of Income Tax

I.T.A. No. 951 /Mds/2009

Assessment Year : 2004- 05

The Assistant Commissioner of Income Tax Vs Indian Additives Limited

O R D E R

PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER :

These are appeals filed by the assessee and Revenue respectively, for assessment year 2004-05, both directed against an order dated 27.3.2009 of Commissioner of Income Tax (Appeals)-XI, Chennai.

2. Assessee in its appeal has raised only one issue which is against the direction of the CIT(Appeals) that 75% of the royalty expenditure alone should be allowed as revenue expenditure and the balance has to be considered as capital expenditure. Revenue in its appeal has also raised a related issue that the CIT(Appeals) erred in allowing 75% of running royalty claimed, as revenue expenditure. Only other issue arising in Revenue’s appeal is regarding deletion of addition of Rs.  1,22,19,429/- made on account of revision of arms length price.

3. We will first take up the issue regarding royalty. Assessee had claimed a sum of Rs.  2,75,24,000/- as revenue outgo on amounts paid to one M/s Chevron Oronite Company LLC, USA (COCL). As per the assessee, this was running royalty. The A.O., however, was of the opinion that this was a capital expenditure, since assessee had acquired a right to use technology and technical know how from M/s COCL. However, the A.O. allowed depreciation thereof.

4. In assessee’s appeal before the CIT(Appeals), argument of the assessee was that it was a revenue expenditure and such payments made to M/s COCL were separate and distinct from lump sum payments of royalties given to M/s COCL. Ld. CIT(Appeals) after considering submission of the assessee, held that 75% of the payments could be considered as revenue expenditure and only 25% could be disallowed as capital expenditure. For this, he placed reliance on the order of his predecessor for assessment year 1999- 2000 in assessee’s own case.

5. Now before us, as already mentioned, both parties are aggrieved. Assessee is aggrieved that 25% of the payment was considered as capital expenditure, whereas, Revenue is aggrieved that 75% of the payment was allowed as revenue expenditure by the CIT(Appeals). Learned A.R. submitted that this Tribunal in assessee’s own case, allowed the claim of the assessee as revenue expenditure for assessment year 1999-2000 to 2002-03. Copy of the order of this Tribunal in I.T.A. Nos. 2138/Mds/2998 & 700 to 702/Mds/2009 and in I.T.A. Nos. 2238/Mds/2008 & 971 to 973/Mds/2009 dated 1 3^th November, 2009 was filed.

6. Learned D.R. fairly admitted that this issue stood decided in favour of assessee.

7. We have perused the orders and heard the rival contentions. We find that the same issue regarding royalty payment mad to M/s COCL was considered by this Tribunal in the orders referred supra. It was held by this Tribunal at para 2.17 of its order dated 13^th November, 2009, as under:-

“2.17 In the facts and circumstances of the case, when the royalty payments shall be computed at a particular percentage of sales priced, and if there was no sales, no royalty would be payable. Merely because goods were produced in India by the assessee acquiring the technical process from the foreign collaborator, it cannot be said that the royalty payment is referable to the production house / manufacturing of the products. The technical know-how for the manufacturing process was acquired by the assessee against a lump sum payment of royalty and subsequent to that, if there is no sale of the product manufactured by the assessee, then there would be no royalty payable. Thus, the running royalty payable has no nexus or direct connection with the manufacture of the product. The liability to pay the royalty arises only when there is a sale. Therefore, we are of the view that the running royalty cannot be said to be a capital expenditure. We do not find any rationale in bifurcation of the running royalty and treating one part as capital and the other part as revenue by the learned Commissioner of Income Tax (Appeals) without any basis. The decision relied upon by the learned Commissioner of Income Tax (Appeals) is on the facts that the assessee could continue to use the technology even after the expiry of the period of payment of royalty. Therefore, when the lump sum royalty was separately agreed and paid, then the running royalty, in the facts and circumstances, would only be a revenue expenditure paid for the use of the licence, trade mark and technical information for a particular period. Accordingly, this issue is decided in favour of the assessee and against the Revenue.”