SC ENVIRO AGRO INDIA P.LTD, MUMBAI V. DCIT CIR 3(3), MUMBAI

ITA 6060/MUM/2011

• Counselvise Citation: [2012] 119 COUNSELVISE.COM (IT) 9238 (ITAT-MUMBAI)
• Duration Of Justice: 1 year(s) 3 month(s) 19 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 19-12-2012
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: K
• Next Hearing Date: 12-12-2012
• Assessment Year: 2005-2006
• Appeal Filed On: 30-08-2011
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: AJEET KUMAR JAIN
• Assessee Lawyers: R MURLIDHAR
• Keywords: Transfer pricing; Business expenditure; International transaction; Commercial expediency
• Section: 143(3); 37(1)

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL MUMBAI BENCH K, MUMBAI BEFORE SHRI P.M.JAGTAP, ACCOUNTANT MEMBER AND SHRI VIJAY PAL RAO, JUDICIAL MEMBER. I.T.A. NO.6060/MUM/2011. ASSESSMENT YEAR : 2005-06 M/S SC ENVIRO AGRO INDIA PVT. LTD., DY. COMMISSIONER OF INCOME-TAX, 3/33, MAKER CHAMBERS VI, VS . CIRCLE-3(3), MUMBAI. 220 NARIMAN POINT, MUMBAI 4000021. PAN AAFGS 6405F APPELLANT. RESPONDENT . APPELLANT BY : SHRI R. MURLIDHAR. RESPOND ENT BY : SHRI AJEET KUMAR JAIN. DATE OF HEARING : 12-12-2012 DATE OF PRONOUNCEMENT : 19-12-2012. O R D E R PER P.M. JAGTAP, A.M. THIS APPEAL FILED BY THE ASSESSEE IS DIRECTED AGAI NST THE ORDER OF LEARNED CIT(APPEALS)-15, MUMBAI DATED 28-06-2011 AND THE S OLITARY ISSUE ARISING OUT OF THE SAME FOR OUR CONSIDERATION RELATES TO THE ADDIT ION MADE BY THE AO AND SUSTAINED BY THE LEARNED CIT(APPEALS) TO THE EXTENT OF RS.64,75,807/- BY WAY OF TRANSFER PRISING (T.P.) ADJUSTMENT ON ACCOUNT OF RO YALTY. 2. THE ASSESSEE IN THE PRESENT CASE IS A COMPANY WH ICH IS ENGAGED IN THE BUSINESS OF MANUFACTURING OF PESTICIDES AND ITS INT ERMEDIATE CHEMICALS. THE RETURN OF INCOME FOR THE YEAR UNDER CONSIDERATION WAS FILE D BY IT ON 28-10-2005. DURING THE COURSE OF ASSESSMENT PROCEEDINGS, THE AO NOTICE D THAT THE ASSESSEE HAS PAID A ROYALTY AMOUNTING TO RS.67,93,080/- BEING 5% OF THE NET SALES TO ITS ASSOCIATE 2 ITA NO.6060/MUM/2011 ENTERPRISE M/S SUMITOMO CHEMICAL CO. LTD., JAPAN (S CJ) FOR TECHNICAL KNOWHOW OBTAINED FOR USE IN MANUFACTURING OF PESTICIDES ETC . HE, THEREFORE, MADE A REFERENCE U/S 92CA(1) TO THE TPO FOR DETERMINING THE ARMS LEN GTH PRICE IN RELATION TO THE SAID INTERNATIONAL TRANSACTION OF THE ASSESSEE COMP ANY WITH ITS AE. THE TPO NOTED FROM THE TP STUDY REPORT FURNISHED BY THE ASSESSEE THAT THE ASSESSEE COMPANY WAS HAVING MANUFACTURING AGREEMENT WITH SCJ ON THE ONE HAND AND SELLING AGREEMENT WITH SCI, ANOTHER AE, ON THE OTHER HAND. ACCORDING TO HIM, THE ASSESSEE THUS WAS A CONTRACT MANUFACTURER AND THERE WAS NO JUSTIFICATIO N FOR PAYMENT OF ROYALTY MADE BY IT TO SCJ. HE, THEREFORE, REQUIRED THE ASSESSEE TO SHOW CAUSE WHY THE ROYALTY PAID TO SCJ SHOULD NOT BE DISALLOWED. IN REPLY, IT WAS SUBMITTED ON BEHALF OF THE ASSESSEE THAT THE GOODS WERE BEING MANUFACTURED BY IT USING THE TECHNICAL KNOWHOW AND ASSISTANCE FROM SCJ AND THE SAME WERE MARKETED AND SOLD BY SCI. IT WAS CONTENDED THAT THE ROYALTY THUS WAS PAID TO DIFFERENT PARTY AND NOT TO THE PARTY WHICH HAD SOLD THE GOODS. IT WAS ALSO CONTEND ED THAT THE GOODS WERE NOT MANUFACTURED BY THE ASSESSEE COMPANY AS PER THE REQ UIREMENT OF SCI SO AS TO SAY THAT THE ASSESSEE COMPANY WAS DOING ANY CONTRACT MA NUFACTURING ON THEIR BEHALF. IT WAS SUBMITTED THAT THE ASSESSEE WAS MANUFACTURING THE GOODS ON ITS OWN ACCOUNTS TAKING ALL THE RISKS, LIABILITIES AND RESPONSIBILIT Y RELATED TO THE MANUFACTURING. IT WAS CONTENDED THAT THE MANUFACTURING OF GOODS BY TH E ASSESSEE WAS IN ANY CASE NOT POSSIBLE WITHOUT THE TECHNICAL KNOWHOW AND ASSISTAN CE FROM SCJ AND THE PAYMENT OF ROYALTY TO SCJ THUS WAS ESSENTIAL AND NECESSARY TO CARRY ON MANUFACTURING ACTIVITY OF THE ASSESSEE COMPANY. 3. THE SUBMISSIONS MADE BY THE ASSESSEE AS ABOVE WE RE NOT FOUND ACCEPTABLE BY THE TPO AND HE MADE AN ADJUSTMENT OF RS.67,93,08 0/- ON ACCOUNT OF ROYALTY TAKING THE ARMS LENGTH PRICE OF THE ROYALTY AT NIL MAINLY FOR THE FOLLOWING REASONS GIVEN IN HIS ORDER : 3 ITA NO.6060/MUM/2011 1) THE ARRANGEMENT IS THAT THE ASSESSEE MANUFACTURE S GOODS AVAILING TECHNOLOGY OF ITS AE LOCATED IN JAPAN. THE JAPANESE ENTITY APPROVES THE PARTY TO WHOM THE GOODS HAVE TO BE SOLD, WHICH IS IN THIS CASE IS ALSO A GROUP ENTITY. THE SALES ARE NOT ALLOWED TO B E MADE TO ANYONE ELSE. THEREFORE, THERE IS A RESTRICTION ON THE ASSE SSEE FOR COMMERCIAL EXPLOITATION OF THE TECHNICAL KNOW-HOW. THEREFORE, IT IS VERY MUCH EVIDENT FROM THE NATURE OF ASSESSEES AGREEMENTS WI TH THE AE THAT THE FUNCTIONS BEING PERFORMED BY THE ASSESSEE IS NOTHIN G BUT CONTRACT MANUFACTURING. 2) IN A CONTRACT MANUFACTURING ARRANGEMENT THERE IS NO JUSTIFICATION FOR PAYMENT OF ROYALTY FOR USE OF TECHNICAL KNOW-HOW ET C. SINCE IT IS RESPONSIBILITY OF THE PRINCIPAL TO PROVIDE THE SAME TO THE CONTRACT MANUFACTURER. ACCORDINGLY, ADDITION OF RS.67,93,080/- WAS MADE BY THE AO TO THE TOTAL INCOME OF THE ASSESSEE RELYING ON THE ORDER OF THE TPO BY WAY OF TP ADJUSTMENT IN THE ASSESSMENT COMPLETED U/S 143(3) VIDE AN ORDER DATED 26-11-2008. 4. AGAINST THE ORDER PASSED BY THE AO U/S 143(3), A N APPEAL WAS PREFERRED BY THE ASSESSEE BEFORE THE LEARNED CIT(APPEALS) CHALLE NGING THE ADDITION MADE BY WAY OF TP ADJUSTMENT IN RESPECT OF ROYALTY PAYMENT. IT WAS SUBMITTED ON BEHALF OF THE ASSESSEE BEFORE THE LEARNED CIT(APPEALS) THAT A LL THE PURCHASES OF RAW MATERIAL, PACKING MATERIAL AND OTHER CONSUMABLES REQUIRED FOR THE MANUFACTURING HAVING BEEN PURCHASED BY IT ON ITS OWN ACCOUNT AND THE SAL ES TAX ALSO HAVING BEEN PAID ON THE SALE OF GOODS MANUFACTURED, IT WAS NOT A CASE O F CONTRACT MANUFACTURING AS HELD BY THE AO/TPO. IT WAS ALSO POINTED OUT THAT THE ASS ESSEE HAD SOLD THE GOODS NOT ONLY TO SCI BUT ALSO TO THIRD PARTY CUSTOMERS. IT WAS FURTHER SUBMITTED THAT THE AGREEMENT BETWEEN THE ASSESSEE AND SCJ DID NOT IMPO SE ANY OBLIGATION ON THE ASSESSEE AS ALLEGED BY THE TPO EXCEPT THAT THE FINI SHED GOODS WERE TO BE SOLD ONLY TO THE APPROVED PARTIES. IT WAS ALSO CONTENDED ON B EHALF OF THE ASSESSEE THAT WHILE MAKING THE TP ADJUSTMENT, THE PROCEDURE LAID DOWN I N THE ACT WAS NOT FOLLOWED BY THE TPO INASMUCH AS THERE WAS NO DETERMINATION OF A NY ARMS LENGTH PRICE BY HIM 4 ITA NO.6060/MUM/2011 BY CONSIDERING ANY COMPARABLE CASES. IT WAS SUBMITT ED THAT EVEN NONE OF THE METHODS PRESCRIBED IN THE STATUTE WAS FOLLOWED BY T HE TPO FOR DETERMINING THE ARMS LENGTH PRICE OF THE ROYALTY. IT WAS CONTENDED THAT THE ADDITION MADE BY THE AO/TPO BY WAY OF TP ADJUSTMENT IN RESPECT OF ROYALT Y PAYMENT WAS NOT SUSTAINABLE AND THE SAME SHOULD BE DELETED. 5. THE LEARNED CIT(APPEALS) DID NOT FIND MERIT IN T HE SUBMISSIONS MADE ON BEHALF OF THE ASSESSEE MAINLY FOR THE FOLLOWING REA SONS GIVEN IN PARAGRAPH NO. 3.9 TO 3.12 OF HIS IMPUGNED ORDER : 3.9 THE APPELLANT IS HAVING ITS BUSINESS MODEL OF BEING EXCLUSIVE MANUFACTURER FOR THE AE I.E. SUMITOMO CHEMICAL CO. LTD., JAPAN (SCJ). THOUGH THE FINISHED PRODUCT MAY NOT BE DIREC TLY CONSUMED BY THE SCJ BUT ARE SOLD WITH THE APPROVAL OF SCJ TO AN OTHER GROUP COMPANY IN INDIA I.E. SCI INDIA OR TO THE OTHER APP ROVED THIRD PARTY. FURTHER THE SALES TO THE APPROVED THIRD PARTIES ARE CONSISTENTLY REDUCING AND TO THE EXTENT OF NEARLY 95% SALES DURI NG THE YEAR UNDER CONSIDERATION ARE TO THE SCI INDIA. FURTHER RESTRIC TION ON THE FREE COMMERCIAL EXPLOITATION OF THE KNOW HOW IMPORTED AN D THE VERY FACT THAT THE MARKETING FOR THE PRODUCT PRODUCED BY THE APPELLANT IS CONTROLLED BY THE SCJ, CLEARLY BRINGS OUT THAT THE APPELLANT IS EXCLUSIVE MANUFACTURER FOR SCJ, AKIN TO CONTRACT MANUFACTURER , WHICH SUPPLIES ITS FINISHED GOODS TO ANOTHER GROUP COMPANY APPROVE D BY THE SCJ. THE CASE LAWS RELIED UPON BY THE APPELLANT TO SUPP ORT ITS POINT OF VIEW THAT THE APPELLANT IS NOT INTO JOB WORK OR CON TRACT MANUFACTURING ARE DISTINGUISHABLE ON FACTS AS THEY DO NOT DEAL WI TH ISSUE ON HAND OF PAYMENT OF ROYALTY WHEN THE PURCHASE OF RAW MATERIA L AND FINAL PRODUCT SALES ARE FULLY CONTROLLED. 3.10 UNDER SUCH ARRANGEMENTS THERE CANNOT BE ANY JU STIFICATION FOR THE PAYMENT OF ROYALTY. ONE CAN UNDERSTAND THE JUSTIFIC ATION OF ROYALTY PAYMENT IF THE MANUFACTURED GOODS ARE SOLD FULLY TO THIRD PARTIES. HOWEVER, IF SUCH GOODS ARE MANUFACTURED AND SOLD WI THIN THE GROUP, I AGREE WITH THE AO/TPO THAT THERE IS NO JUSTIFICATIO N FOR ROYALTY PAYMENT. SINCE THE JAPANESE COMPANY HOLDS 90% SHARE OF THE APPELLANT, IT AUTOMATICALLY BECOMES A PARTY TO ENJO Y THE PROFITS EARNED BY THE APPELLANT AND HENCE THE ROYALTY OVER AND ABO VE SHARE PROFITS 5 ITA NO.6060/MUM/2011 WOULD NOT BE JUSTIFIED UNDER THE FACTS AND CIRCUMST ANCES OF THE CASE AND WHEN THE FREE PURCHASE OF RAW MATERIAL, FREE CO MMERCIAL EXPLOITATION OF THE KNOW HOW AND SALES TO THE THIR D PARTIES ARE NOT PERMITTED AT THE FREEDOM OF THE APPELLANT. I, THERE FORE, HOLD THAT THE ARMS LENGTH PRICE OF ROYALTY IN RESPECT OF FINISHED PRODUCT SOLD TO THE INDIA AE WILL BE NIL. SO FAR AS GOODS SOLD TO THIRD PARTIES ARE CONCERNED, THE APPELLANT WILL BE ENTITLED FOR DEDUC TION OF CORRESPONDING ROYALTY. 3.11 AS FAR AS APPLICATION OF SECTION 92C(3) IS CON CERNED IT IS MENTIONED THAT THE BENCHMARKING DOWN BY THE APPELLANT IS NOT FOUND TO BE ACCEPTABLE IN THE FACTS OF THE CASE. THE CLAUSE (A) AND (C) OF SECTION 92C(3) ARE CLEARLY ATTRACTED IN THE CASE OF THE APP ELLANT. 3.12 REGARDING THE APPELLANTS OBJECTION ABOUT METH OD ADOPTED BY THE TPO/AO TO DETERMINE THE ARMS LENGTH PRICE, I AM OF THE VIEW THAT ONCE IT IS HELD THAT THE APPELLANT IS A CONTRACT MA NUFACTURER OR ITS BUSINESS MODEL IS THAT OF BEING EXCLUSIVE MANUFACTU RER AND WHEN THE FREE COMMERCIAL EXPLOITATION OF THE KNOW HOW IS NOT PERMISSIBLE AND THAT ITS MARKET IS CONTROLLED, THEN THE ROYALTY ORD INARILY WILL NOT BE PAYABLE. ACCORDINGLY THE METHOD ADOPTED HERE WOULD BE THE CUP METHOD AS THE MOST APPROPRIATE METHOD. IN A COMPARA BLE SITUATION, APPLYING CUP AS THE MOST APPROPRIATE METHOD, THE RO YALTY ATTRIBUTABLE TO SUCH PORTION OF SALES WHICH ARE MADE TO THE GROU P COMPANY IN INDIA WOULD BE DETERMINED AS NIL. 6. FOR THE REASONS GIVEN ABOVE, THE LEARNED CIT(APP EALS) HELD THAT THE ROYALTY PAID BY THE ASSESSEE TO SCJ TO THE EXTENT IT WAS IN RESPECT OF SALE TO THIRD PARTY CUSTOMER WAS AT ARMS LENGTH WHEREAS THE ARMS LENGTH PRICE IN RESPECT OF BALANCE AMOUNT OF ROYALTY WAS NIL. SINCE THE SALE TO THIRD PARTY CUSTOMER OF THE ASSESSEE DURING THE YEAR UNDER CONSIDERATION WAS RS.3.7 CROR ES, HE ALLOWED THE PAYMENT OF ROYALTY IN RESPECT OF THE SAID PAYMENT TO THE EXTEN T OF RS.3,17,273 AS AT ARMS LENGTH AND SUSTAINED THE ADJUSTMENT MADE IN RESPECT OF THE BALANCE ROYALTY OF RS.64,75,807/-. AGGRIEVED BY THE ORDER OF THE LEARN ED CIT(APPEALS), THE ASSESSEE HAS PREFERRED THIS APPEAL BEFORE THE TRIBUNAL. 6 ITA NO.6060/MUM/2011 7. WE HAVE HEARD THE ARGUMENTS OF BOTH THE SIDES AN D ALSO PERUSED THE RELEVANT MATERIAL ON RECORD. AS AGREED BY THE LEARNED REPRES ENTATIVES OF BOTH SIDES, THE ISSUE INVOLVED IN THIS APPEAL OF THE ASSESSEE IS SQUARELY COVERED IN FAVOUR OF THE ASSESSEE BY THE ORDER OF THE TRIBUNAL DATED 7 TH NOVEMBER, 2012 PASSED IN ITA NO. 2057 AND 2058/MUM/2009 FOR ASSESSMENT YEARS 2003-04 AND 2004 -05 WHEREIN THE SIMILAR ADDITION MADE BY WAY OF TP ADJUSTMENT IN RESPECT OF ROYALTY PAID BY THE ASSESSEE TO ITS AE SUMITOMO CHEMICAL CO. LTD., JAPAN UNDER T HE SAME AGREEMENT HAS BEEN HELD TO BE NOT SUSTAINABLE EITHER IN LAW OR ON THE FACTS OF THE CASE BY THE TRIBUNAL FOR THE FOLLOWING REASONS GIVEN IN PARAGRAPH NO. 11 TO 14 OF ITS ORDER : 11. WE HAVE CONSIDERED THE RIVAL CONTENTIONS. AS SEEN F ROM THE RECORD ASSESSEE ENTERED INTO AN AGREEMENT FOR OBTAINING LI CENSE TO MANUFACTURE SPECIFIED INSECTICIDES AND PESTICIDES AND AGREED TO PAY 5% ROYALTY ON THE VALUE ADDITION AND RBI HAS APPROVED THE ROYALTY AT 5% FOR A PERIOD OF SEVEN YEARS. TILL ASSESSMENT YEAR 2003-04 THERE WAS NO DISPUTE WITH R EFERENCE TO THE PAYMENT OF ROYALTY AND EVEN IN THE ORIGINAL ASSESSMENT COMPLET ED THE ROYALTY WAS ALLOWED AS ELIGIBLE EXPENDITURE IN THE ORDER UNDER SECTION 143(3). IN ASSESSMENT YEAR 2004-05 THIS ISSUE FOR THE FIRST TIME WAS EXAMINED BY THE TPO ON THE BASIS OF THE TP REPORT OF ASSESSEE WHEREIN ASSESSEE SUBMITTE D THAT THE ARRANGEMENT IS IN THE NATURE OF CONTRACT MANUFACTURERS IN THE FAR ANALYSIS. SINCE THIS WAS ADMITTED BY ASSESSEE, THE TPO WITHOUT EXAMINING THE NATURE OF AGREEMENT OR THE MANUFACTURING ACTIVITY OF ASSESSEE OR ANY OTHER INCIDENTAL FACTOR CAME TO A CONCLUSION THAT SINCE ASSESSEE ADMITTED TO BE A CON TRACT MANUFACTURER, THERE IS NO NEED TO PAY ANY ROYALTY. IN HIS ORDER THE TPO AL SO MENTIONS THAT ASSESSEE WAS NOT MAKING ANY SALES TO OUTSIDE PARTIES, THE FA CT OF WHICH IS NOT CORRECT. ON THE BASIS OF HIS OBSERVATIONS, HE ARRIVED AT THE RO YALTY ARMS LENGTH PRICE AT NIL. 12. THE HON'BLE DELHI HIGH COURT IN THE CASE OF CIT VS. EKL APPLIANCES (SUPRA) HAS EXAMINED A SIMILAR ISSUE WHETHER THE TP O HAS POWER TO RESTRICT IT TO NIL WHEN HE WAS SUPPOSED TO HAVE DETERMINED THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION. THE HON'BLE HIGH COURT A FTER EXAMINING THE FACTS OF THE CASE HELD AS UNDER: 19. THERE IS NO REASON WHY THE OECD GUIDELINES SHOU LD NOT BE TAKEN AS A VALID INPUT IN THE PRESENT CASE IN JU DGING THE ACTION OF THE TPO. IN FACT, THE CIT (APPEALS) HAS R EFERRED TO AND APPLIED THEM AND HIS DECISION HAS BEER: AFFIRME D BY THE TRIBUNAL. THESE GUIDELINES, IN A DIFFERENT FORM , HAVE BEEN RECOGNIZED IN THE TAX JURISPRUDENCE OF OUR COUNTRY EARLIER. IT HAS BEEN HELD BY OUR COURTS THAT IT IS NOT FOR THE REVENUE AUTHORITIES TO DICTATE TO THE ASSESSEE AS TO HOW HE SHOULD CONDUCT HIS BUSINESS AND IT IS NOT FOR THEM TO TELL THE ASSESSEE 7 ITA NO.6060/MUM/2011 AS TO WHAT EXPENDITURE THE ASSESSEE CAN INCUR. WE M AY REFER TO A FEW OF THESE AUTHORITIES TO ELUCIDATE THE POIN T. IN EASTERN INVESTMENT LTD. V. CIT, (1951) 20 ITR 1, IT WAS HELD BY THE SUPREME COURT THAT 'THERE ARE USUALLY MANY WAYS IN WHICH A GIVEN THING CAN BE BROUGHT ABOUT IN BUSINESS CIRCLE S BUT IT IS NOT FOR THE COURT TO DECIDE WHICH OF THEM SHOULD HA VE BEEN EMPLOYED WHEN THE COURT IS DECIDING A QUESTION UNDE R SECTION 12(2) OF THE INCOME TAX ACT'. IT WAS FURTHE R HELD IN THIS CASE THAT' IT IS NOT NECESSARY TO SHOW THAT TH E EXPENDITURE WAS A PROFITABLE ONE OR THAT IN FACT AN Y PROFIT WAS EARNED'. IN CIT V. WALCHAND & CO. ETC., (1967) 65 ITR 381, IT WAS HELD BY THE SUPREME COURT THAT IN APPLYING THE TEST OF COMMERCIAL EXPEDIENCY FOR DETERMINING WHETHER THE EXPENDITURE WAS WHOLLY AND EXCLUSIVELY LAID OUT FOR THE PURPOSE OF BUSINESS, REASONABLENESS OF THE EXPENDITURE HAS TO BE JUDGED FROM THE POINT OF VIEW OF THE BUSINESSMAN AND NOT OF THE REVENUE. IT WAS FURTHER OBSERVED THAT THE RULE THAT EXPENDITURE CAN ONLY BE JUSTIFIE D IF THERE IS CORRESPONDING INCREASE IN THE PROFITS WAS ERRONEOUS . IT HAS BEEN CLASSICALLY OBSERVED BY LORD THANKERTON IN HUG HES V. BANK OF NEW ZEALAND, (1938) 6 ITR 636 THAT 'EXPENDI TURE IN THE COURSE OF THE TRADE WHICH IS UN-REMUNERATIVE IS NONE THE LESS A PROPER DEDUCTION IF WHOLLY AND EXCLUSIVELY M ADE FOR THE PURPOSES OF TRADE. IT DOES NOT REQUIRE THE PRESENCE OF A RECEIPT ON THE CREDIT SIDE TO JUSTIFY THE DEDUCTION OF AN E XPENSE'. THE QUESTION WHETHER AN EXPENDITURE CAN BE ALLOWED AS A DEDUCTION ONLY IF IT HAS RESULTED IN ANY INCOME OR PROFITS CAME TO BE CONSIDERED BY THE SUPREME COURT AGAIN IN CIT V. RAJENDRA PRASAD MOODY, (1978) 115 ITR 519, AND IT W AS OBSERVED AS UNDER:- 'WE FAIL TO APPRECIATE HOW EXPENDITURE WHICH IS OTHERWISE A PROPER EXPENDITURE CAN CEASE TO BE SUCH MERELY BECAUSE THERE IS NO RECEIPT OF INCOME. WHATEVER IS A PROPER OUTGOING BY 11'AY OF EXPENDITURE MUST BE DEBITED IRRESPECTIVE OF 'WHETHE R THERE IS RECEIPT OF INCOME OR NOT. THAT IS THE PLAI N REQUIREMENT OF PROPER ACCOUNTING AND THE INTERPRETATION OF SECTION 57(III} CANNOT BE DIFFERE NT. THE DEDUCTION OF THE EXPENDITURE CANNOT, IN THE CIRCUMSTANCES, BE HELD TO BE CONDITIONAL UPON THE MAKING OR EARNING OF THE INCOME.' IT IS NOTEWORTHY THAT THE ABOVE OBSERVATIONS WERE M ADE IN THE CONTEXT OF SECTION 57(III) OF THE ACT WHERE THE LAN GUAGE IS SOMEWHAT NARROWER THAN THE LANGUAGE EMPLOYED IN SEC TION 8 ITA NO.6060/MUM/2011 37(1) OF THE ACT. THIS FACT IS RECOGNIZED IN THE JU DGMENT ITSELF. THE FACT THAT THE LANGUAGE EMPLOYED IN SECTION 37(1 ) OF THE ACT IS BROADER THAN SECTION 57(III) OF THE ACT MAKE S THE POSITION STRONGER. 20. IN THE CASE OF SASSOON J. DAVID & CO. PVT. LTD. V. CIT, (1979) 118 ITR 261 (SC), THE SUPREME COURT REFERRED TO THE LEGISLATIVE HISTORY AND NOTED THAT WHEN THE INCOME TAX BILL OF 1961 WAS INTRODUCED, SECTION 37(1) REQUIRED THAT TH E EXPENDITURE SHOULD HAVE BEEN INCURRED 'WHOLLY, NECE SSARILY AND EXCLUSIVELY' FOR THE PURPOSES OF BUSINESS IN OR DER TO MERIT DEDUCTION. PURSUANT TO PUBLIC PROTEST, THE WORD 'NE CESSARILY' WAS OMITTED FROM THE SECTION. 21. THE POSITION EMERGING FROM THE ABOVE DECISIONS IS THAT IT IS NOT NECESSARY FOR THE ASSESSEE TO SHOW THAT ANY LEG ITIMATE EXPENDITURE INCURRED BY HIM WAS ALSO INCURRED OUT O F NECESSITY. IT IS ALSO NOT NECESSARY FOR THE ASSESSE E TO SHOW THAT ANY EXPENDITURE INCURRED BY HIM FOR THE PURPOS E OF BUSINESS CARRIED ON BY HIM HAS ACTUALLY RESULTED IN PROFIT OR INCOME EITHER IN THE SAME YEAR OR IN ANY OF THE SUB SEQUENT YEARS. THE ONLY CONDITION IS THAT THE EXPENDITURE S HOULD HAVE BEEN INCURRED 'WHOLLY AND EXCLUSIVELY' FOR THE PURP OSE OF BUSINESS AND NOTHING MORE. IT IS THIS PRINCIPLE THA T INTER ALIA FINDS EXPRESSION IN THE OECD GUIDELINES, IN THE PAR AGRAPHS WHICH WE HAVE QUOTED ABOVE. 22. EVEN RULE 10B(1)(A) DOES NOT AUTHORIZE DISALLOW ANCE OF ANY EXPENDITURE ON THE GROUND THAT IT WAS NOT NECESSARY OR PRUDENT FOR THE ASSESSEE TO HAVE INCURRED THE SAME OR THAT IN THE VIEW OF THE REVENUE THE EXPENDITURE WAS UN-REMU NERATIVE OR THAT IN VIEW OF THE CONTINUED LOSSES SUFFERED BY THE ASSESSEE IN HIS BUSINESS, HE COULD HAVE FARED BETTE R HAD HE NOT INCURRED SUCH EXPENDITURE. THESE ARE IRRELEVANT CONSIDERATIONS FOR THE PURPOSE OF RULE L0B. WHETHER OR NOT TO ENTER INTO THE TRANSACTION IS FOR THE ASSESSEE TO D ECIDE. THE QUANTUM OF EXPENDITURE CAN NO DOUBT BE EXAMINED BY THE TPO AS PER LAW BUT IN JUDGING THE ALLOWABILITY THER EOF AS BUSINESS EXPENDITURE, HE HAS NO AUTHORITY TO DISALL OW THE ENTIRE EXPENDITURE OR A PART THEREOF ON THE GROUND THAT THE ASSESSEE HAS SUFFERED CONTINUOUS LOSSES. THE FINANC IAL HEALTH OF ASSESSEE CAN NEVER BE A CRITERION TO JUDGE ALLOW ABILITY OF AN EXPENSE; THERE IS CERTAINLY NO AUTHORITY FOR THAT. WHAT THE TPO HAS DONE IN THE PRESENT CASE IS TO HOLD THAT THE AS SESSEE OUGHT NOT TO HAVE ENTERED INTO THE AGREEMENT TO PAY ROYALTY/ BRAND FEE, BECAUSE IT HAS BEEN SUFFERING LOSSES CON TINUOUSLY. 9 ITA NO.6060/MUM/2011 SO LONG AS THE EXPENDITURE OR PAYMENT HAS BEEN DEMONSTRATED TO HAVE BEEN INCURRED OR LAID OUT FOR THE PURPOSES OF BUSINESS, IT IS NO CONCERN OF THE TPO T O DISALLOW THE SAME ON ANY EXTRANEOUS REASONING. AS PROVIDED I N THE OECD GUIDELINES, HE IS EXPECTED TO EXAMINE THE INTE RNATIONAL TRANSACTION AS HE ACTUALLY FINDS THE SAME AND SUITA BLE ADJUSTMENT BUT A WHOLESALE DISALLOWANCE OF THE EXPE NDITURE, PARTICULARLY ON THE GROUNDS WHICH HAVE BEEN GIVEN B Y THE TPO IS NOT CONTEMPLATED OR AUTHORIZED. 13 THE PRINCIPLES LAID DOWN BY THE HONBLE DELHI HIGH COURT IN THE ABOVE SAID CASE EQUALLY APPLIES TO THE FACTS OF THE CASE. EVEN THOUGH THE LEARNED CIT (DR) TRIED TO DISTINGUISH ON THE REASON THAT THE FACTS A RE DIFFERENT THE RATIO DECIDENDI IN THE ABOVE SAID CASE IS ABOUT THE POWERS OF THE T PO TO DETERMINE THE ALP AT NIL VALUE. AS IN THE ABOVE SAID CASE WHAT THE TPO H AS DONE IN THE PRESENT CASE IS ALSO TO HOLD THAT ASSESSEE NEED NOT PAY ANY ROYA LTY ON THE PRESUMPTION THAT ASSESSEE IS A CONTRACT MANUFACTURER. THE TPO HAS TO EXAMINE WHETHER THE PRICE PAID OR AMOUNT PAID WAS AT ARMS LENGTH OR NOT UNDER THE PROVISIONS OF TRANSFER PRICING AND ITS RULES. THE RULE DOES NOT AUTHORIZE THE TPO TO DISALLOW ANY EXPENDITURE ON THE GROUND THAT IT WAS NOT NECESSARY OR PRUDENT FOR ASSESSEE TO HAVE INCURRED THE SAME. ON THAT PRINCIPLE ALONE, WE CANNOT APPROVE THE ORDER OF THE TPO AS IT NOT ONLY CONSIDERED THE FACTS WRON GLY BUT ALSO EXCEEDED THE JURISDICTION AVAILABLE TO THE TPO IN EXAMINING THE ARMS LENGTH PRICE ON A TRANSACTION. 14. APART FROM THE LEGAL POSITION STATED ABOVE, E VEN ON MERITS THE DISALLOWANCE OF ENTIRE ROYALTY PAYMENT ON SALES TO AE WAS NOT WA RRANTED. ASSESSEE ADMITTED THAT IT WRONGLY CLAIMED IN THE TP REPORT THAT THE A RRANGEMENT IS IN THE NATURE OF CONTRACT MANUFACTURING. HOWEVER, AS SEEN FROM THE A GREEMENT ENTERED BY THE ERSTWHILE HOME REMEDIES LTD WITH SCCL IT IS FOR OBT AINING LICENSE FOR MANUFACTURING SPECIFIED PRODUCTS. SINCE THE TECHNOL OGY IS SPECIFIC TO THE MANUFACTURING SPECIFIC ITEMS, THE CONDITION IS THAT THE INTERMEDIATES ARE TO BE IMPORTED FROM THE SCCL. HOWEVER, AFTER IMPORTING TH E INTERMEDIATES ASSESSEE IS ALSO USING THE INDIGENOUS MATERIAL IN MANUFACTURING THE SPECIFIED INSECTICIDES AND PESTICIDES. IT IS ALSO ACQUIRING PACKING MATERI AL REQUIRED FOR PACKING INSECTICIDES AND PESTICIDES PRODUCED IN 5 LTRS AND 20 LTRS CONTAINERS. SINCE THESE INSECTICIDES AND PESTICIDES ARE FOR SPECIFIED FOR USAGE (MOSQUITO REPELLENTS ETC.,) THESE PRODUCTS ARE MAINLY SOLD TO AE AND ALS O TO OTHER THIRD PARTIES WHO REQUIRE THE INSECTICIDES AND PESTICIDES SO MANUFACT URED. ASSESSEE IS ALSO PAYING EXCISE DUTY AND OTHER TAXES. THE PRINCIPAL COMPANY IS NOT PAYING ANY AMOUNT TO THE ASSESSEE COMPANY TOWARDS MANUFACTURING IF IT WERE TO BE CONSIDERED AS CONTRACT MANUFACTURING. EVEN THOUGH ADMITTEDLY ASSE SSEE MENTIONED IN THE TP REPORT THAT THE ARRANGEMENT IS IN THE NATURE OF CON TRACT MANUFACTURING, THE FACTS INDICATES OTHERWISE. THE ROYALTY WAS PAID AS PER THE AGREEMENT ON THE VALUE-ADDED PRICE TO THE SCCL FOR PROVIDING THE LIC ENSE AND TECHNICAL KNOWHOW. THIS PAYMENT IS INDEPENDENT OF WHETHER ASSESSEE IS FULL FLEDGED MANUFACTURER OR A CONTRACT MANUFACTURER OR A TOLL MANUFACTURER A ND THE NATURE OF 10 ITA NO.6060/MUM/2011 MANUFACTURING ACTIVITY CANNOT HAVE ANY BEARING ON T HE PAYMENT OF ROYALTY. AS SUBMITTED, THE ROYALTY IS NOT PAID ON THE ENTIRE SA LES PRICE BUT ONLY ON THE VALUE ADDED PRICE WHICH WAS WORKED OUT SEPARATELY. WE ARE ALSO SURPRISED THAT THE CIT (A) RESTRICTED THE ROYALTY ON THE SALES TO AE O NLY WHEN THE SALES TO AE WAS AT ARMS LENGTH PRICE AS THAT OF SALES TO THIRD PART IES. THERE IS NO LOGIC IN ALLOWING THE SALES MADE TO THE THIRD PARTIES AND NO T ON SALES MADE TO AE. AS ALREADY STATED THE SAID AGREEMENT WAS APPROVED BY T HE RBI FOR PAYMENT OF ROYALTY AT 5% FOR A PERIOD OF 7 YEARS. THERE WAS AL SO NO SUCH DISALLOWANCE IN EARLIER YEARS. SINCE WE DO NOT FIND ANY REASON TO R ESTRICT THE ROYALTY TO NIL, WE ARE NOT IN A POSITION TO APPROVE THE ORDER OF THE C IT (A) ON THIS ISSUE. WITHOUT GOING INTO THE NITTY-GRITTY OF DETERMINING WHETHER ASSESSEE IS A CONTRACT MANUFACTURER OR A FULL-FLEDGED MANUFACTURER, SINCE ROYALTY IS PAID FOR ALLOWING ASSESSEE IN UTILIZING THE TECHNICAL KNOWHOW AND THE LICENSE FOR MANUFACTURING ACTIVITY, WE ARE OF THE OPINION THAT THE PAYMENT OF ROYALTY IS WHOLLY AND EXCLUSIVELY FOR THE PURPOSE OF BUSINESS. IN VIEW OF THIS, WE ALLOW ASSESSEES GROUND AND DIRECT AO TO ALLOW THE ROYALTY AS CLAIME D. 8. AS THE ISSUE INVOLVED IN THE YEAR UNDER CONSIDER ATION AS WELL AS ALL THE MATERIAL FACTS RELEVANT THERETO ARE SIMILAR TO ASSE SSMENT YEARS 2003-04 AND 2004- 05, WE RESPECTFULLY FOLLOW THE ORDER OF COORDINATE BENCH OF THIS TRIBUNAL DATED 7 TH NOVEMBER, 2012 (SUPRA) PASSED IN ASSESSEES OWN CAS E FOR ASSESSMENT YEARS 2003- 04 & 2004-05 AND DELETE THE ADDITION MADE BY THE AO AND SUSTAINED BY THE LEARNED CIT(APPEALS) BY WAY OF TP ADJUSTMENT IN RESPECT OF ROYALTY PAYMENT. 9. IN THE RESULT, THE APPEAL OF THE ASSESSEE IS ALL OWED. ORDER PRONOUNCED ON THIS 19 TH DAY OF DEC., 2012. SD/- SD/- (VIJAY PAL RAO) (P.M. JAGTAP) JUDICIAL MEMBER ACCOUNTANT MEMBER MUMBAI, DATED : 19 TH DEC., 2012. WAKODE 11 ITA NO.6060/MUM/2011 COPY TO : 1. APPELLANT. 2. RESPONDENT 3. C.I.T. 4. CIT(A) 5. D.R., K-BENCH. (TRUE COPY) BY ORDER ASSISTANT REGISTRAR, ITAT, MUMBAI.