Mercedes-Benz India Pvt. Ltd. Vs Dy. C.I.T. (ITAT Pune)
Held that the assessee has secured the license right to use the know-how for the period of the agreement and the royalty expenditure in this regard is therefore revenue in nature.
Facts-
The assessee, Mercedes Benz India Pvt. Ltd., is a company incorporated under the provisions of the Companies Act, 1956 and is mainly engaged in the manufacture and sale of Mercedes Benz passenger cars in the Indian market MB India currently manufacturing E.C.S. GL class and CLA class of passenger cars in India. Pursuant to a ‘Technology License Agreement’ entered by the Appellant with Daimler AG, it has paid an amount of Rs. 12,51,11,877/- as royalty to Daimler AG. AO disallowed the royalty expenses by considering it to be a capital expenditure.
Conclusion-
Held that from the terms and conditions of the agreement, it is clear that MB India’s rights ends on termination of the agreement. It also evident that MB India has neither acquired any assets on an outright basis nor secured any enduring advantage. The benefit secured by MB India is essentially a license right to use the know-how for the period of the agreement and the royalty expenditure in this regard is therefore revenue in nature.
FULL TEXT OF THE ORDER OF ITAT PUNE
This Appeal preferred by the assessee emanates from the direction of the learned Dispute Resolution Panel (hereinafter referred to as ‘DRP‘ for short) dated 29-11-2016 for A.Y. 2012-13 as per the following grounds of appeal.
“Based on the facts and circumstances of the case and in law, the Appellant respectfully craves to prefer an appeal against the order dated 30 January 2017 passed by the learned Deputy Commissioner of Income-tax, Circle – 9, Pune (hereinafter referred as ‘the learned Assessing Officer’) (received by the Appellant on 31 January 2017) under section 143(3) read with section 144C(13) of the Income-tax Act, 1961 (‘the Act’) on the following grounds which are independent of and without prejudice to each other:
On the facts and circumstances of the case and in law, the learned Assessing Officer:
A. Grounds of appeal in respect of Transfer pricing adjustment
Ground No.1-Transfer pricing adjustment should be deleted as being bad in law
Erred in making the reference to the TPO without proper application of mind to the facts on records, without recording his reasons for any necessity or expediency, without legal and valid approval of CIT and ignoring the conditions stipulated in section 92C(3)/92CA(1) and hence, the same is not in accordance with the provisions of the Act.
The transfer pricing adjustment and the Transfer Pricing Order passed should be quashed as being bad in law or illegal or void ab initio.
Ground No.2 – General ground related to Transfer pricing adjustment amounting to Rs. 110,33.85,000 Erred in law and in circumstances by not considering the transfer pricing analysis documented in transfer pricing report for A Y 2012-13.
Ground No.3 – Rejecting the combined transaction approach
Erred in law and in facts by rejecting the combined transaction approach adopted by the Appellant at entity level for benchmarking the various international transactions entered into by the Appellant.
Ground No.4 – Rejecting all the comparable companies
Erred in law and in facts by rejecting all the companies identified by the Appellant in the transfer pricing study report of A Y 2012-13 as comparable companies.
Ground No.5 – Comparing the gross margin of controlled transaction with another controlled transaction
Erred on the facts and in law by comparing the gross margin from international transaction pertaining to import of CBUs with the international transaction pertaining to import of spares (i.e. both being controlled transactions of the Appellant itself).
Ground No.6 – Applying Resale Price Method and comparing gross margin from international transaction pertaining to import of CBUs with the international transaction pertaining to import of Spares
Erred on the facts and in law by applying Resale Price Method (‘RPM’) and comparing gross margin of controlled transaction of import of Completely Built Unit cars (‘CBUs’) with gross margin of functionally non comparable controlled transaction of import of spares of Appellant.
Ground No.7 – Adjustment for differences in function, asset and risk profile
Erred in law and facts in making transfer pricing adjustment to the purchase price of CBUs without granting adjustment to account for differences in functions, assets and risks of the spares segment vis a-vis CBU segment.
Ground No.8 – Rejecting the separate Transaction Net Margin Method search
Erred in facts and in circumstances of the case by rejecting the separate TNMM search provided (on a without prejudice basis) by the Appellant for separate benchmarking of the international transaction of import of CBUs.
Ground No.9 – Rejecting certain additional Indian companies and accepted certain inappropriate Indian companies as com parables
Erred on facts and in law by rejecting certain additional Indian companies identified by the Appellant during the course of assessment proceeding on without prejudice basis and also erred in accepting certain inappropriate Indian companies rejected by the Appellant as not comparable.
Ground No. 10 – Computation of operating margin of the Appellant at entity level, without taking into consideration the excess custom duty paid on imports by Appellant vis-a-vis comparable companies
Erred on the facts of the case and in law by computing the operating margin of the Appellant without taking into consideration the excess custom duty paid on imports by MB India.
Ground No. 11 – Computation of operating margin of the Appellant at entity level, without excluding additional cost on account of abnormal foreign exchange rate movement
Erred on the facts of the case and in law by computing the operating margin of MB India without factoring the effect of abnormal foreign exchange movement on its total cost.
Ground No. 12 – Computation of operating margin of MB India at entity level without excluding extra-ordinary expenses on account of excess demurrage/detention charges and litigation claim
Erred on the facts of the case and in law by computing the operating margin of the Appellant at entity level without excluding extra-ordinary demurrage and litigation expenses incurred by MB India.
Ground No. 13 – Transfer pricing adjustment to be limited to the international transactions with AEs only (without prejudice ground)
Erred in facts and in the circumstances of the case by not restricting! proportionating the transfer pricing adjustment to the international transaction with AEs only while making adjustment at entity level.
Ground No. 14 – Inappropriate use of single year data
Erred on the facts and in circumstances of the case and in law by not considering multiple year data for determining the arm’s length price.
Ground No. 15 – Transfer pricing adjustment without giving benefit of +/-5 percent as available under proviso to section 92C(2) of the Act
Erred in computing the arm’s length price of the international transactions, without taking into account the benefit of +/- 5 percent variation from transfer price as available under proviso to section 92C(2) of the Act.
B. Grounds related to corporate tax adjustments
Ground No. 16 – Disallowance of Royalty expenditure Erred on the facts and in circumstances of the case in disallowing the royalty expenditure of Rs 12,51,11,887 as capital expenditure for AY 2012-13.
Ground No. 17 – Disallowance of Homologation expenditure
Erred on the facts and in circumstances of the case in disallowing the expenditure on homologation of Rs 2,34,85,773 as capital expenditure for AY 2012-13.
2. That before coming into the facts of the case let us understand background of the business model of the assessee i.e. Mercedes Benz India Pvt. Ltd. Mercedes Benz is a company incorporated under the provisions of the Companies Act, 1956 and is mainly engaged in the manufacture and sale of Mercedes Benz passenger cars in the Indian market MB India currently manufacturing E.C.S. GL class and CLA class of passenger cars in India.
Import of CBUs
Generally, an automobile company starts with importing cars in the form of Completely Built units (CBUs) for three reasons:
For assessing and penetrating into the market and then subsequently, depending upon the market situation start importing cars in the form of semi knocked down (‘SKD‘) condition, complete knock down (‘CKD‘) condition and then eventually operating at part level.
For bringing in new products available with AE as CBU, which will take time to supply the same in SKD / CKD / Parts level and also some times to bridge a sudden gap of demand and manufacturing capacity.
For bringing in niche models which will be sold in few numbers and may not be currently viable to manufacture in India but important to offer entire range to the customers. With respect to activity of import of CBUs, MB India wishes to submit that MB India manufactures S- Class, E-Class and C-Class range of Mercedes-Benz passenger cars in India. In addition to manufacturing operations, MB India also imports certain Mercedes-Benz models in the niche segment for resale in India.
With respect to activity of import of CBUs, MB India wishes to submit that MB India manufactures S- Class, E-Class and C-Class range of Mercedes-Benz passenger cars in India. In addition to manufacturing operations, MB India also imports certain Mercedes-Benz models in the niche segment for resale in India.
Such imports are restricted to models not manufactured by MB India as, given the current demand, it is not commercially sustainable to manufacture the same. Such import of CBUs is carried out with the view to cater and maintain the markets for the Mercedes-Benz models which are not manufactured by MB India. This ensures that the customer continues to use Mercedes-Benz cars and could be targeted for local manufacturing cars in the future.
Thus, with respect to volume models like the E-Class & C-Class models of cars manufactured by MB India, the Appellant submits that these models followed the path of CBUs / SKD- CKD – Part level sale. Further, MB India submits that it has now started manufacturing M-Class and GL-Class models which were earlier imported as CBUs in FY 2011-12. The manufacturing of M Class and GL class started in FY 2012-13 and FY 2013-14 respectively and the models which are currently imported in the form of CBUs are A-Class, B-Class models, etc.
Also, it is pertinent to note that there is always a time lag between the introduction of a new model in the international market and the commencement of manufacturing in India by the company. To shorten the time lag and generate a demand, CBUs are imported to meet the market requirements till local production starts in the company. Further, whenever there is higher market demand than the planned local production, CBUs are imported to bridge the gap between demand and supply. This is required as the lead time between planning and manufacturing cycle is more than six months.
In view of the above, the Appellant submits that import and sale of CBUs is important for assessing the market condition for a particular range of cars which could be targeted for manufacturing by MB India in future or to bring in niche models which will be sold in few numbers and not currently economically viable to manufacture in India. Further, CBU imports are made to bring new products available with AE as CBU, but will take time to supply the same in SKD / CKD / Parts level and also some times to bridge a sudden gap of demand and manufacturing capacity.
Warranty commitments/replacements of spare parts
In common parlance, automobile manufacturer generally sells the car to its dealers, who in turn sell cars to customers. Generally, the sale of car is covered by a manufacturer‘s warranty provided for 1 or 2 years and the charges towards that warranty is embedded in the sale price.
Similarly, in case of MB India, when the Appellant sells its cars to various customers through its dealers, they have an attached warranty condition in respect of cars manufactured as well as imported as CBUs i.e. in the event of failure of any part / component, a faulty design/manufacture, defects arises which were not originally visualized, then in such case MB India would provide for replacement of spare parts. MB India provides warranty for 2 years and additionally for 1 year at no extra cost. Further, MB India provides extended warranty for fourth year on payment, under Star Care Program.
This warranty is administered through dealers who addresses the warranty claims of the customers and resolves the same. The dealer recovers the warranty charges (i.e. cost of labour + cost of the spare parts replaced/ repaired + applicable taxes) from MB India.
Further as per the dealership agreement, it is clearly evident that
