pri Royalty paid by a taxpayer computed even on sales made to the Associated Enterprise is at arm’s length Royalty paid by a taxpayer computed even on sales made to the Associated Enterprise is at arm’s length

Case Law Details

Case Name : ACIT Vs. Sona Okegawa Precision Forging Ltd. (ITAT Delhi)
Appeal Number :
Date of Judgement/Order :
Related Assessment Year :

Brief : Royalty paid by a taxpayer computed even on sales made to the Associated Enterprise is at arm’s length. Further, a taxpayer paying royalty to its Associated Enterprise can make additional payments for technical services rendered by personnel deputed by the Associated Enterprise.

Citation : ACIT Vs. Sona Okegawa Precision Forging Ltd. [2010-TII-41-ITAT-DEL-TP]

Court : Income-tax Appellate Tribunal, Delhi

Delhi bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of ACIT v. Sona Okegawa Precision Forging Ltd. [2010-TII-41-ITAT-DEL-TP], has upheld that the payment of royalty by a taxpayer to an Associated Enterprise (AE) based on the sales made to the AE itself complies with the arm’s length standard where the taxpayer is not a contract manufacturer and the royalty payment is recovered from the AE as part of the selling price. Further, the Tribunal upheld that a taxpayer, obligated to pay royalty to its AE, can also make payment for technical services rendered by personnel deputed by the AE provided the royalty agreement evidences that the services rendered by the deputed personnel are not the responsibility of the AE.

Facts of the case

  • · During Financial Year 2003-04, the taxpayer has paid royalty to its AE which was benchmarked under the Comparable Uncontrolled Price (CUP) relying on the ceiling under the Foreign Exchange Management Regulations as the arm’s length price.
  • · During the course of Transfer Pricing assessment proceedings, the Transfer Pricing Officer (TPO) proposed Transfer Pricing adjustment in relation to the royalty transaction based on the following observations:

o The taxpayer has not entered into agreement for payment of royalty to any independent third party and hence there does not exist any comparable uncontrolled data;

o Royalty has been paid on total sales of the taxpayer, including sales made to AE. Royalty paid to AE computed on the basis of sales made to the AE is not compliant with the arm’s length standard; and

o The taxpayer has paid additional amount to the AE for deputation of technical advisor & joint managing director. As the services rendered by these personnel were part of the technical services for which the taxpayer was paying royalty, no additional charge was due to the AE for services rendered by the deputed personnel.

  • · Aggrieved by the order of the Assessing Officer (AO), the taxpayer filed an appeal with the Commissioner of Income Tax (Appeals) [CIT(A)]. The CIT(A) deleted the addition proposed by the TPO.

Tribunal’s Ruling

The Tribunal, after considering all the submissions and perusing the material on record, upheld the order of the CIT(A) in favour of the taxpayer. The key aspects of Tribunal’s order are summarized below:

  • · The royalty paid by the taxpayer computed based on sales made to AE is at arm’s length as the taxpayer is not a contract manufacturer. Further, the amount paid as royalty was recovered by the taxpayer from the AE as part of the sale price and thus the transaction was revenue neutral.
  • · The amount paid by the taxpayer for the deputed personnel is at arm’s length considering that:

o The payment was an obligation of the taxpayer under the know-how license agreement;

o The remuneration for deputation of employees was determined based on similar payments made to the taxpayer’s own personnel; and

o The deputation of the technical personnel was in accordance with the shareholder agreement and these payments were not linked to the know-how license agreement.

Our Comments

The judgement highlights the need to have robust inter-company agreements particularly where the services received from AE(s) under different agreement appear overlapping/ duplicative. Furthermore, in relation to the manner in which royalty has to be determined, the ruling underlines the significance of Functions, Assets & Risks analysis which would establish whether an entity is not a contract manufacturer justifying royalty payment even on sales made to the AE.
NF

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