Transfer Pricing: Scope in the context of expenditure (royalty payment) explained

Reebok India Co vs. ACIT (ITAT Delhi)

The assessee paid royalty at the rate of 5% to its associated enterprise and claimed that the same was at arm’s length basis by applying the CUP method. The TPO and DRP determined the ALP of the royalty at Nil on the basis that (a) the approval given by the Government for payment of royalty did not automatically mean that the transaction was at arm’s length; (b) the assessee had not furnished a cost benefit analysis, (c) the technology had in fact not helped the assessee in earning better margins. It was held that as the technology had not contributed to the assessee’s profitability and there was no commercial benefit received, no independent enterprise would have make payment for royalty for the technology and so its ALP had to be determined at Nil. On appeal by the assessee to the Tribunal, HELD reversing the TPO & DRP:

(a) The TPO’s argument that the assessee need not have paid for the technology as it did not derive any benefit therefrom is not acceptable. The assessee is free to conduct business in the manner it deems fit and the commercial and business expediency of incurring any expenditure has to be seen from the assessee’s point of view. The Revenue cannot step into the shoe of the assessee and decide what is prudent for the business. On facts, the very survival of the assessee in the industry depended upon the licence and technology & know how provided by the AE. There has been a considerable increase in the sales figures and the growth in revenue clearly demonstrates the benefits derived by the assessee from the use of technology;

(b) the payment of royalty was approved by the Government of India. Though it is not conclusive proof, the said approval of the Government has to be given consideration while considering the arms length price of the transaction;

(c) Under Rule 10B(1)/ s. 92C(2), the arm’s length price has to be determined by one of the five methods which is found to be most appropriate method. While the assessee rightly considered the CUP method for determining the ALP, the TPO’s conclusion that the arms length price of the royalty payment should be NIL without specifying any cogent basis is not sustainable (EKL Appliances 345 ITR 241 (Del), Ericsson 146 TTJ 708 (Del), ThyssenKrupp Industries 154 TTJ 689(Mum), Dresser Rand 55 SOT 167 (Mum), SC Enviro Agro 143 ITD 195 (Mum) etc followed)