The case of Voith Siemens Hydro Private Limited vs. ACIT involves transfer pricing proceedings. The focus of the proceedings is on the expenses incurred for engineering services and administrative support services. This article analyzes the details presented during the case, including the examination of invoices, the nature of the services, and the arguments put forth by the parties involved. The ultimate outcome and implications of the case are also discussed.
Analysis: During the transfer pricing proceedings, Voith Siemens Hydro Private Limited submitted details of expenses incurred for engineering services and administrative support services provided by its associated enterprise (AE). The invoices contained information such as invoice numbers, dates, gross amounts in Euros, and their equivalent amounts in INR. The expenses totaled Rs. 1,89,53,444, with Rs. 1,46,21,403 relating to engineering services and Rs. 43,32,041 related to administrative support services.
The Transfer Pricing Officer (TPO) examined the invoices and found that the AE charged the assessee for services rendered during the OTO (order to offer) stage of projects, which included OTO-support and application work. The TPO acknowledged that the engineering services were essential for the assessee, a start-up company with limited experience in the hydro power industry. The services provided by the AE included sales support, product engineering, feasibility studies, and technical assistance using Computational Fluid Dynamics (CFD) software.
The case involved a discussion on the characterization of the assessee as an EPC (Engineering, Procurement, and Construction) contractor and the comparison with companies providing engineering services. The assessee argued that its activities in subsequent assessment years were similar to the AY 2007-08, which had been characterized as an EPC contractor. The assessee presented a detailed search process that resulted in identifying comparable companies engaged as EPC contractors, supporting the arm’s length standard for the international transactions.
Regarding administrative support services, the assessee clarified that they included public relations, human resources, and corporate sourcing. The charges for these services were allocated based on the proportion of sales among various Voith entities without any markup. The outsourcing of certain works to subcontractors, such as erection and commissioning, was highlighted to refute the notion that these services were unnecessary due to outsourcing.
The assessee contended that the segmental approach for benchmarking its international transactions related to outbound engineering services should be accepted. The Ld. TPO’s rejection of the segmental approach at the entity level was challenged, with duly certified segmental financials provided to support the assessee’s position.
Conclusion: Based on the facts presented and the legal position, it is evident that the expenses incurred by Voith Siemens Hydro Private Limited for engineering services and administrative support services were necessary and commercially expedient for its business operations. The objections raised during the transfer pricing proceedings were adequately addressed by the assessee. As a result, the addition made by the transfer pricing adjustment was deemed unnecessary, and the appeal of the assessee was allowed. The case highlights the importance of accurately analyzing and justifying expenses in transfer pricing matters.
FULL TEXT OF THE ORDER OF ITAT DELHI
The appeal by the assessee is directed against the assessment order dated 19.10.2011 of the Ld. ACIT, Circle-17(1), New Delhi (“AO”) pertaining to assessment year (“AY”) 2 007-08.
2. The assessee is a private limited company which develops, designs, procures, erects, installs and commissions all electrical and mechanical parts of hydro-power projects. It executes Engineering, Procurement and Commissioning (“EPC”) contracts. During the AY 2007-08 the assessee held license for use of the Voith Trademarks and also the Technical know-how of Voith Siemens Hydro Power Generation Grubh & Co. KG for its EPC
3. For AY 2007-08 the assessee filed its return of income on 30.09.2007 declaring income of Rs. 6,41,35,888/-. Following the order of Transfer Pricing Officer, Hyderabad (“TPO”) dated 30.06.2010 an addition of Rs. 5,42,39,943/- was proposed as an adjustment/ difference in the arm’s length price (“ALP”) vide the draft order dated 16.12.2010 by the Ld. AO after the case was transferred to him under section 127 of the Income Tax Act, 1961 (“the Act”). The addition comprised of two variables which are as under:-
|1. In respect of payments towards intra-group services made||Rs. 2,48,50,136/-|
|2. In respect of payments towards royalty made||Rs. 2,73,89,807/-|
3.1 The assessee filed objections before the Hon’ble Dispute Resolution Panel – 1, New Delhi (“DRP”). Vide order dated 28.09.2011 the Hon’ble DRP directed the Ld. AO that he shall not make an addition of Rs. 2,93,89,807/- as the payment of royalty was at ALP. In respect of payment of intra-group services the Hon’ble DRP directed that the income of the assessee be enhanced by Rs. 1,89,53,444/- as the assessee has not been able to discharge the onus placed upon it. Accordingly, the Ld. AO made an addition of Rs. 1,89,53,444/- as against Rs. 2,48,50,136/- proposed by the Ld. TPO and completed the assessment on income of Rs. 8,30,89,332/- including therein the impugned addition on 19.10.2011 under section 143(3) read with section 144C of the Act.
3.2 The appeal by the assessee was dismissed by the Tribunal vide order dated 12.04.20 13 in ITA No. 5886/Del/201 1 against which the appeal was filed before the Hon’ble Delhi High Court. Vide order dated 11.02.2014 the Hon’ble Delhi High Court observed that the Tribunal has not recorded its independent finding and remitted the matter back to the Tribunal to consider and record reasons in respect of the contentions of the assessee and the Revenue urged before it. Accordingly, the Tribunal reheard the matter. In para 12 of its order dated 04.05.2016 the Tribunal observed that since the payment made by the assessee to its Associated Enterprise (“AE”) for services rendered was basically an expenditure incurred for the purposes of business, the same are to be determined under section 37(1) of the Act, if allowable or not and this issue is in exclusive domain of the AO to be determined. In para 13, the Tribunal further observed that the AO has neither examined nor recorded any finding whatsoever if the payment to the tune of Rs. 1,89,53,444/- made to the AE for availing services from its AE is an expenditure incurred for the purposes of business under section 37(1) of the Act, rather passed the assessment order in mechanical manner in consonance with the directions issued by the TPO/DRP. The Tribunal went on to observe further that moreover, when the TPO has not disputed that the services were availed by the assessee from its AE, the question of determining the ALP of group charges to the tune of Rs. 1,89,53,444/- does not arise because it was to be done by the AO only. With the observations above, the Tribunal restored the matter to the file of the Ld. AO to determine the issue as to the payment of group charges by the assessee to its AE afresh.
3.3 The assessee again challenged the order of the Tribunal by way of appeal before the Hon’ble Delhi High Court under section 260A of the Act for considering the question of law “whether the ITAT erred in not deciding the issue before it instead of remanding it to the AO/TPO?”. The Hon’ble Delhi High Court in its order dated 25.09.2017 in ITA 10/2017 observed in para 7 that the question before the ITAT for consideration was “whether the issue as to the payment on account of other group charges made by the assessee to its AE for services rendered was to be determined by the TPO/DRP or it was to be determined by the AO under section 3 7(1) of the Act.” Since the ITAT did not decide the issue on merits and remanded the matter to the file of the AO, the Hon’ble Delhi High Court restored the matter to the file of the ITAT for decision on merits.
3.4 This is how the matter came up before us. We heard the Ld. Representative of the parties, carefully considered their arguments and perused the material on records.
4. The impugned addition of Rs. 1,89,53,444/- to the income of the assessee is made on the basis of observations of the Hon’ble DRP that the assessee has not been able to discharge the onus placed upon it in respect of the payment of intra-group services rendered by the AE to the assessee.
4.1 The group charges comprised of Rs. 1,46,21,403/- for Engineering services rendered by the AE and Rs. 43,32,041/- for Administrative Support services aggregating to Rs. 1,89,53,444/-. The relevant observations of the Hon’ble DRP are as follows :-
“…The DRP has noticed that the kind of support that the assessee claims to have received is similar to the services that have been included in the agreement covering the payment of royalty. It does not appear that any independent party would have made a payment for such services when they are already covered by another agreement. Besides this it appears that the assessee has sub-contracted the works that have been awarded to it to third party. This seems to be an additional ground to believe that the assessee would not have required the level of technical input that would be required if it were to carry out the tasks on its own. After consideration of the arguments put forward by the TPO and the arguments made by the assessee before this panel, the DRP is of the view that the assessee has not been able to discharge the onus placed upon it in respect of the payment of Rs. 1,89,53,444/-.”
4.2 With regard to payment of Rs. 1,46,21,403/- for Engineering services availed by the assessee from its AEs the contentions of the assessee are as under :-
i) The Hon’ble DRP misconstrued the assessee’s business model and overlooked the evidence adduced to support the ‘real benefits’ the assessee received in return for “Engineering services”.
ii) The Hon’ble DRP drew an erroneous conclusion that there is an overlap between royalty payments and charges paid for availing Engineering services. In doing so, the Hon’ble DRP did not appreciate that royalty paid by the assessee pursuant to Licence and Technical Collaboration Agreement (“Licence Agreement”) is for the right to use proprietary and/or patented technology, etc. whereas the charges for availing Engineering services are paid by the assessee pursuant to OTO and OTC Agreement (“Agreement”) for availing project–specific assistance based on requisitions made by the assessee to fulfil customer’s obligations.
iii) The Hon’ble DRP did not appreciate that bulk of the Engineering services are availed in the Offer to Order (OTO) stage (i.e tender filing stage) when no sale is generated and accordingly, there is no question of it overlapping with Licence Agreement.
iv) Further, even in few instances where Engineering services availed by the assessee run concurrently with payment of royalty, the Hon’ble DRP disregarded the fact that the Engineering services are availed for project- specific work, which does not fall within the ambit of the Licence Agreement.
v) The Hon’ble DRP made an erroneous observation, though in passing reference, on page 6 of its directions that there is no need to avail “Engineering services” as the assessee is sub-contracting a portion of work to third party vendors on need basis.
vi) The Hon’ble DRP disregarded/overlooked the evidence in the form of Certificate of an Auditor who certified the appropriateness of cost allocated to the assessee with respect to Engineering services during the relevant period.
vii) The Hon’ble DRP summarily rejected the “Cost Plus Method” identified as the Most Appropriate Method under section 92C(1) of the Act by the assessee to test the Arms length nature of charges paid in connection to Engineering services availed under the agreement.
viii) The Hon’ble DRP misconstrued the business model of the assessee and functional characterisation as an Engineering service provider and disregarded the fact that the assessee is an EPC contractor. Accordingly the Hon’ble DRP upheld incorrect set of comparables to arrive at an erroneous conclusion that the assessees net operating profit was not in sinc with the industry standards/benchmarks.
ix) The Hon’ble DRP did not give any consideration to the corroborative analysis placed on record by the assessee to justify the Arms Length nature of Engineering services on an aggregated basis using Transactional Net Margin Method (TNMM).
4.3 Regarding payment of Rs. 43,32,041/- for administrative support services availed by the assessee, it was the contention of the assessee that the Hon’ble DRP arrived at a prima facie incorrect conclusion that the administrative support services availed by the assessee from its AEs in the nature of sourcing, public relations etc. form part of Engineering services. The findings of the Hon’ble DRP in this regard is perverse on facts.
4.4 The response of the assessee to the Ld. TPO’s observation that no such group charges were paid by the assessee in the preceding years is that the Engineering services were necessitated during the accounting year 2006-07 because the assessee started tendering for contracts which included supply of critical components like turbines and generators.
4.5 The assessee also contended that documentary evidence with regard to receipt by the assessee of Engineering services was filed before the Ld. TPO/DRP. It is pointed out that the Ld. TPO on examining the invoices noticed that the AE had charged the assessee on the ground that it tendered services such as OTO support and application work in respect of various projects for which tenders were submitted.
5. Perusal of the material on record reveals that despite taking note of the fact that the AEs tender services such as OTO support and application work in respect of various projects for which tenders were submitted, the Ld. TPO recorded the finding that the assessee failed to demonstrate that it actually received the services. This, to our view is blowing hot and cold in the same breath. Moreover, whether or not the services were rendered by the payees and whether or not the services were received by the payer assessee cannot be the subject matter of consideration by the Ld. TPO. In taking this view, we are supported by the decision of the Hon’ble Delhi High Court in CIT vs. Cushman and Wakefield (India) (P) Ltd. (2014) 367 ITR 730 (DEL).
5.1 The Hon’ble Bombay High Court in the case of Coca Cola India (P) Ltd. vs. Asstt. Registrar representing ITAT (2014) 368 ITR 847 (Bom.) that where there was enough material on record enabling Tribunal to decide issues raised in respect of allowance of service charges, matter was to be decided by the Tribunal; it should not have remanded the matter to Assessing Officer.
5.2 In CIT vs. Fotroc Chemicals India (P) Ltd. (2016) 290 CTR 221 (KAR) the Hon’ble Karnataka High Court observed that where TPO opined that the assessee had not received any services from its AE while Tribunal after examining material on record, opined that services rendered were concerning with assessee’s business and no addition could be made in determining ALP, it was not required to remand matter back by keeping said question once again open for consideration by TPO.
5.3 The Hon’ble Supreme Court held in the case of Sassoon J. David & Co. (P) Ltd. vs. CIT (1979) 118 ITR 261 (SC) that it is for the assessee to decide whether any expenditure should be incurred in the course of his or its business.
5.4 Hon’ble Calcutta High Court held in the case of Ashok Surana vs. CIT (2016) 384 ITR 267 (Cal.) that for allowing expenditure, the question always shall be whether the assessee has been able to prove that the expenditure has been incurred by him for the purpose of his business. So long as there is a reasonable nexus between the expenditure and the business the expenditure will be regarded as having been incurred for the purposes of the business.
5.5 The Courts also unanimously agree that the principle of commercial expediency cannot be ignored and that commercial expediency must be judged in the context of current socio-economic thinking. Thus, in deciding whether the payment was made for purposes of business, the correct approach would be to see whether it was made on grounds of commercial expediency.
5.6 In CIT vs. Dalmia Cement (Bharat) Ltd. 254 ITR 377 (Del) Hon’ble Delhi High Court held that contractual payment relating to business need not be disallowed unless it suffered from “the vice of collusiveness or colourable devices”.
5.7 It is held in the case of Ormerods (India) (P) Ltd. vs CIT 36 ITR 329 (BOM) that once an outlay is made for the purpose of the business, it need not turn out to be profitable. It is a mistake to suppose that any deductible expenditure must not only be incurred for the purpose of trade but must also be profitably laid out. The decision (supra) of Hon’ble Bombay High Court has been approved by the Supreme Court in CIT vs. Rajender Prasad Modi 115 ITR 519 (SC).
5.8 The Hon’ble Supreme Court held in the case of CIT vs. Dhanrajgirji Rajanarsingirji 91 ITR 544 (SC) that it is not open to the department to prescribe what expenditure an assessee should incur and in what circumstances he should incur to that expenditure. Every businessman knows his interest best.
5.9 It has been held by the Hon’ble Supreme Court in L.H. Sugar Factory & Oil Mills (P) Ltd. vs. CIT 125 ITR 293 (SC) that where an assessee claims a deduction the onus is on him to bring all material facts on record to substantiate his claim.
6. Let us examine the facts of the assessee’s case in the light of the law set out above.
6.1 During the course of transfer pricing proceedings the assessee submitted details of Group expenses from 01.04.2006 to 31.03.2007 charged by the AE to the assessee containing therein invoice No., date, gross amount in Euro and its equivalent INR amounting in all to Rs. 1,89,53,444/- consisting of Rs. 1,46,21,403/- in respect of Engineering services and Rs. 43,32,041/- relating to Administrative Support services.
6.2 The Ld. TPO examined the invoices and found that the AE has charged the assessee on ground that it rendered services such as OTOsupport and application work in respect of various projects for which tenders were submitted. The Ld. TPO further noticed that in support of each invoice, certain names of employees of the AE alongwith man-hours spent for each project are given. These observations of the Ld. TPO support the contention of the assessee that all the engineering services availed by the assessee from the AE were required in the OTO-stage when the bids were placed for the project and before the projects are won.
6.3 It has been explained by the assessee that it is a start-up company with little experience in the hydro power industry whereas the AE has been in international hydro power business for many decades having vast experience in all types of hydro projects. To have an edge over the cutthroat competition in hydra power industry in India, it is indispensable for the assessee to take services of its AE for engineering, primarily at tender filling stage i.e. order to offer stage (OTO stage) as well as at project execution stage i.e. order to cash stage (OTC stage).
6.4 The nature of services rendered by the AE included sales support, product engineering, product development etc. It may also include feasibility studies and studies of cavitations performance. It has also been explained that the technical services are normally provided with the assistance of CFD (Computational Fluid Dynamics) software. CFD studies stimulate the design of a turbine unit and the water flow through the designed component. The AE raised invoices for these services on the actual hours spent by its engineers on various projects wherein the assessee requisitioned for assistance.
6.5 As regards the observation of the Hon’ble DRP/TPO that the services received by the assessee under the Agreement for provision of specific project related services was similar to the support that had been included in the Licence Agreement for which royalty has already been paid, the assessee drew our attention to Article 2 and 3 of the Licence Agreement which carries rights of the assessee as stated below :-
– Grant of non exclusive worldwide right and licence to manufacture, use and sell licensed products (products made in accordance with the patents and technical information owned, controlled or acquired by the AE);
– Grant of non exclusive worldwide right and licence to use the licensed trademarks owned, controlled or acquired by the AE;
– Disclosure and making available the data, drawing, concepts and designs, operating experience, trade secrets, know-how, documents, models etc. owned by the AE.
Article 4 and 5 relate to other technical services to be provided to the assessee on a separate payment. Article 7(3) specifically mentions that the payment in Article 4 for technical assistance and training shall be in addition to the royalty payment.
From the above, it is evidently clear that Engineering services availed by the assessee from the AE under the Engineering service agreement are customised services suiting to the requirement of a particular project and are in addition to the access to the standard designs which are covered under the Licence Agreement. The Engineering services were rendered to facilitate bidding of the projects by the assessee and are evidently distinct from the rights which were granted under the royalty agreement.
6.6 The assessee refuted the observation of the Hon’ble DRP/Ld. TPO regarding benchmarking of the assessee which is an EPC company viz-a-viz the companies engaged in the provision of engineering services. The assessee being an EPC Company cannot be compared with the companies engaged in provision of engineering services. During the AY 2007-08 the activities carried out by the assessee were much broader than the services performed by an Engineering Service Provider. In the subsequent assessment years (AY 2009-10, 2010-11, 2011-12 & 2012-13) the Ld. TPO has accepted the characterization of the assessee and has not disputed the benchmarking analysis concluded on the basis of the comparable companies engaged in EPC business. Since the nature of business carried out by the assessee in the subsequent assessment years is exactly similar to the business carried out in the assessment year 2007-08 following the rule of consistency the assessee should be characterised as an EPC contractor and comparables of such nature should be used to benchmark the results of the assessee. The assessee before the Hon’ble DRP has submitted a detailed search process carried out by it to identify the independent companies engaged as EPC contractor and comparable to the assessee. The search resulted in six comparables companies earning an average net profit margin (NPM) of 6.87%. This shows that the international transactions entered into by the assessee during the AY 2007-08 corresponds to the arm’s length standard.
6.7 The assessee submitted that the Ld. TPO has rejected the segmental approach adopted by the assessee for benchmarking its international transactions pertaining to provision of outbound engineering services (which is only 0.79% of the total turnover of the assessee). The Ld. TPO proceeded to analyse the profitability of the assessee at entity level by alleging that no evidence was filed in support of the margins earned at the segmental level (OP/TC – 56.03%), which is contrary to the facts available on record. The assessee filed duly certified segmental financials with respect to the provision of outbound engineering services before the Hon’ble DRP which were not taken into cognizance by the Hon’ble DRP who only accepted the approach adopted by the Ld. TPO.
6.8 As regards administrative support services, it has been pointed out that these include Public Relations, Human Resources and Corporate Sourcing. The nature of services provided is documented in the service agreement dated 23.06.2006 entered into between the assessee and its AE. Voith Germany had charged the assessee on cost to cost basis (costs allocated in proportion to sales of various Voith Entities) without any markup. The works which were outsourced to the sub-contractors were in the nature of erection and commissioning. In view of this the observation of the Hon’ble DRP that there is no need for availing these services on the ground that some work was outsourced is not tenable. The documentary evidence in support of the benefits derived by the assessee from availment of Engineering services and Administrative services are duly placed on record before us as well as the Hon’ble DRP/AO/TPO.
6.9 During the subsequent years also the assessee availed similar services from its AEs and incurred expenditure as under :-
|Expenses incurred for
Engineering services (in Rs.)
|Expenses incurred for Administrative Support services (in Rs.)|
|2008-09||1,91,24,596 – OTO stage 3,76,28,8 18 – OTC stage||55,37,116|
|2009-10||1,85,02,755 – OTO stage 10,80,00,304 – OTC stage||1,13,42,072|
It has been submitted by the assessee that its case was not picked up for scrutiny in AY 2008-09. No TP adjustment was made in AY 2009-10 likewise no TP adjustment was made in AY 2010-11 and subsequent years.
7. In the background of the above factual matrix and the legal position set out above, it is obvious that in the year of account the assessee availed the Engineering services and Administrative Support services from its AEs as per the service agreement dated 23.06.2006 entered into between the assessee and its AE for which the assessee incurred impugned expenditure. The expenditure has been incurred against invoices raised by the recipient AE which have also been examined during the course of transfer pricing proceedings. There is absolutely no doubt that the impugned expenditure has been incurred for the purposes of assessee’s business carried on by the assessee and that it was commercially expedient as well. The objections raised by the Hon’ble DRP have also been met by the assessee with cogent reasons given therefor. We, therefore, have no hesitation in holding that the impugned addition by way of transfer pricing adjustment is not called for. We direct the Ld. AO to delete the addition and modify the assessment. The assessee succeeds in its appeal.
8. In the result, the appeal of the assessee is allowed.
Order pronounced in the open court on 26th May, 2022.