Akzo Nobel India Ltd., Pune V. Assistant Commissioner of Income-tax,

ITA 743/PUN/2014

• Counselvise Citation: [2016] 133 COUNSELVISE.COM (IT) 2700 (ITAT-PUNE)
• Duration Of Justice: 1 year(s) 10 month(s) 3 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 19-02-2016
• Appeal Filed By: Assessee
• Order Result: Allowed
• Bench Allotted: A
• Next Hearing Date: 04-02-2016
• Assessment Year: 2005-2006
• Appeal Filed On: 15-04-2014
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: NINESH JAIN
• Assessee Lawyers: NINESH JAIN SHRI M K BIJU
• Keywords: Business income; Transfer pricing; Opportunity of being heard; International transaction; Condonation of delay
• Section: 143(3); 10B

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL PUNE BENCH A , PUNE , , BEFORE MS. SUSHMA CHOWLA, JM AND SHRI PRADIP KUMAR KEDIA , AM . / ITA NO. 743 /PN/201 4 / ASSESSMENT YEAR : 20 0 5 - 06 AKZO NOBEL INDIA LIMITED, [ERSTWHILE AKZO NOBEL CHEMICALS (INDIA) LTD.] TELLUS BUILDING, 2 ND FLOOR, 209/1B/1A, RANGE HILLS, PUNE 411020 . / APPELLANT PAN: A ADCA 3941N VS. THE A SST . COMMISSIONER OF INCOME TAX , CIRCLE 1(1), PUNE . / RESPONDENT / APPELLANT BY : SHRI NINESH JAIN / APPELLANT BY : SHRI NINESH JAIN / RESPONDENT BY : SHRI M.K. BIJU, JCIT / DATE OF HEARING : 04 . 0 2 .201 6 / DATE OF PRONOUNCEMENT: 19 . 0 2 .201 6 / ORDER PER SUSHMA CHOWLA, J M : TH IS APPEAL FILED BY THE ASSESSEE IS AGAINST THE ORDER OF CIT (A) - IT/TP , PUNE , DATED 10 . 1 0 .20 1 2 RELATING TO ASSESSMENT YEAR 20 0 5 - 06 AGAINST ORDE R PASSED UNDER SECTION 143(3) OF THE INCOME - TAX ACT , 1961 (IN SHORT THE ACT) . 2 . THE ASSESSEE HAS RAISED THE FOLLOWING GROUNDS OF APPEAL: - ON THE FACTS AND CIRCUMSTANCES OF THE CASE, AND IN LAW; ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 2 1 . THE LD COMMISSIONER OF INCOME - TAX (APPEALS) - IT / TP ('CIT (A)') HAS ERRED ON FACTS AND IN LAW MAKING TRANSFER PRICING ADJUSTMENT FOR ROYALTY PAYMENTS OF RS.64,78,990 BY: 1 . 1 CONSIDERING THE CONTROLLED ROYALTY RATE (PREVAILING BETWEEN TWO OF THE APPELLANT'S GROUP COMPANIES) AS A COMPARABLE TO THE RATE OF ROYALTY A T WHICH THE APPELLANT PAID ROYALTY TO ITS ASSOCIATED ENTERPRISES ('AE'), FOR BENCH MARKING PURPOSE UNDER THE COMPARABLE UNCONTROLLED PRICE ('CUP') METHOD. 1 . 2 HOLDING THAT THE ROYALTY AMOUNT (IN CONNECTION WITH PROVISION OF TECHNOLOGY) NEEDS TO COMPUTED BY D EDUCTING THE COST OF RAW MATERIALS FROM THE SALES VALUE, THEREBY REJECTING THE METHODOLOGY ADOPTED BY THE APPELLANT FOR COMPUTING ROYALTY PAID TO THE AE. 1 . 3 REJECTING THE METHODOLOGY ADOPTED BY THE ASSESSEE FOR COMPUTING ROYALTY, DESPITE THE FACT THAT THE SA ID METHODOLOGY IS IN CONSONANCE WITH THE FEMA GUIDELINES IN THIS REGARD. MAKING TRANSFER PRICING ADJUSTMENT FOR EXPORT OF CERTAIN FINISHED GOODS OF R S. 7,99,500 BY: 1 . 4 DISREGARDING THE UNDERLYING TRANSACTIONAL DIFFERENCES WHILE CONSIDERING THE PRICES CHAR GED (FOR CERTAIN PRODUCTS) TO THIRD PARTIES IN INDIA AS CUPS FOR DETERMINING THE ARM'S LENGTH NATURE OF SIMILAR PRODUCTS EXPORTED TO THE AE. THE ABOVE GROUNDS ARE WITHOUT PREJUDICE TO EACH OTHER YOUR APPELLANT CRAVES LEAVE TO ADD, AMEND, ALTER, WITHDRA W, MODIFY AND/OR SUBSTITUTE, AND TO WITHDRAW THE ABOVE GROUNDS OF APPEAL. 3. THE PRESENT APPEAL IS FILED AFTER DELAY OF 479 DAYS . THE ASSESSEE HAS FILED A PETITION FOR CONDONATION OF DELAY AND ALSO IN SUPPORT, AN AFFIDAVIT, WHICH READS AS UNDER: - AFFIDA VIT I ATUL JEWALIKAR S/O MR. SUDHAKAR JEWALIKAR RESIDENT OF PUNE DO HEREBY SOLEMNLY CONFIRM AND DECLARE AS UNDER: 1 . THAT I AM WORKING AS SITE CONTROLLER IN AKZO NOBEL INDIA LIMITED (FORMERLY KNOWN AS AKZO NOBEL CHEMICALS (INDIA) LIMITED) ('ANCIL') HAVING I TS OFFICE AT TELLUS BUILDING, 2 ND FLOOR, 209/ 1 B /1 A, RANGE HILLS, PUNE - 4 11020 AND ENTRUSTED WITH THE RESPONSIBILITY OF LOOKING AFTER THE TAX MATTERS OF ANCIL AND AS SUCH I AM CONVERSANT WITH THE FACTS OF THIS CASE AND COMPETENT TO SWEAR THIS AFFIDAVIT. 2 . F OR THE YEAR UNDER CONSIDERATION, THE COMPANY FILED ITS RETURN OF INCOME FOR THE FINANCIAL YEAR ('FY') 2004 - 05 (AY 2005 - 06) ON 29.10.2005, DISCLOSING A TOTAL INCOME OF RS.143,698,887. THE RETURN WAS SELECTED FOR SCRUTINY AND ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 3 ACCORDINGLY NOTICE WAS ISSUED UN DER SECTION 143(2) OF THE INCOME - TAX ACT, 1961 ('ACT'). 3 . THE ASSESSMENT PROCEEDING WAS CONCLUDED AFTER, MAKING AN ADDITION OF RS . 72,78,490 TO THE TOTAL INCOME OF THE APPELLANT. 4 . AGGRIEVED WITH THE AFORESAID DISALLOWANCE, THE COMPANY FILED AN APPEAL BEFORE THE COMMISSIONER OF INCOME TAX (APPEALS) - I, PUNE {CIT(A)}. HOWEVER, THE CIT(A) UPHELD THE ORDER OF AO VIDE HIS ORDER DATED OCTOBER, 10, 2012. 5 . THE COMPANY INADVERTENTLY DID NOT FILE AN APPEAL BEFORE THE DUE DATE WITH THE HONBLE INCOME - TAX APPELLATE TRIBU NAL (HON. ITAT), PUNE, AGAINST THE ORDER OF THE COMMISSIONER OF INCOME TAX (APPEALS) - IT/TP, PUNE {CIT(A)} DATED OCTOBER 10, 2012 FOR AY 2005 - 06 DUE TO THE FOLLOWING REASONS: WE HAD RECEIVED THE CIT(A) ORDER FOR AY 05 - 06 ON OCTOBER 23, 2012 AND SIMULTA NEOUSLY RECEIVED AN ASSESSMENT ORDER FOR AY 08 - 09 FROM THE ASSESSING OFFICER ON NOVEMBER 2, 2012. THE ISSUES INVOLVED IN BOTH THE YEARS WERE SIMILAR / IDENTICAL AS WERE THEREFORE PLANNING TO FILE THE APPEAL FOR BOTH THESE YEARS TOGETHER. FURTHER, WE DID NOT SEEK ANY SERVICES RELATING TO FILING AN APPEAL BEFORE THE HON. ITAT FOR AY 2005 - 06 AND AY 2008 - 09 FROM A CHARTERED ACCOUNTANT AS AN APPEAL INVOLVING SIMILAR ISSUES WAS FILED BY THE COMPANY IN CONSULTATION WITH THE AUTHORIZED REPRESENTATIVE FOR AY 06 - 07 AND AY 07 - 08 BEFORE THE HON. ITAT, PUNE . PUNE . HOWEVER, I FILED AN APPEAL FOR AY 08 - 09 ONLY BEFORE THE HON. ITAT ON 2 ND NOVEMBER, 2012, AND WITH RESPECT TO AY 05 - 06 , IT INADVERTENTLY SLIPPED FROM MY MIND FOR FILING AN APPEAL DUE TO OVERSIGHT. 6 . IN VIEW OF THE A BOVE THERE IS A DELAY OF 1 YEAR AND 113 DAYS IN FILING THE APPEAL AGAINST THE ORDER OF THE CIT(A) DATED OCTOBER 10, 2012 FOR AY 20 05 - 06 . SD/ - DEPONENT VERIFICATION THAT I, ATUL JEWALIKAR THE DEPONENT NAMED ABOVE DO HEREBY SOLEMNLY CONFIRM AND DECL ARE THAT THE CONTENTS OF THE ACCOMPANYING AFFIDAVIT ARE TRUE AND CORRECT TO THE BEST OF MY KNOWLEDGE AND BELIEF AND NOTHING HAS BEEN CONCEALED THEREFROM. VERIFIED ON THIS 4 TH DAY OF JULY 2014 AT PUNE. SD/ - DEPONENT ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 4 4. THE LEARNED AUTHORIZED REPRESE NTATIVE FOR THE ASSESSEE STRESSED BEFORE US THAT BECAUSE OF CERTAIN CONFUSION, THE PRESENT APPEAL COULD NOT BE FILED IN TIME. IT WAS POINTED OUT BY THE LEARNED AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE THAT THE ORDERS FROM CIT(A) FOR ASSESSMENT YEAR 2005 - 06 AND ASSESSMENT YEAR 2008 - 09 FROM THE ASSESSING OFFICER UNDER SECTION 144C R.W.S. 143(3) OF THE ACT WERE RECEIVED IN THE MONTH OF OCTOBER, 2012. THE APPEAL AGAINST THE ORDER RELATING TO ASSESSMENT YEAR 2008 - 09 WAS FILED IN 2012. HOWEVER, BY AN INADVER TENT MISTAKE, THE ASSESSEE MISSED TO FILE APPEAL RELATING TO ASSESSMENT YEAR 2005 - 06 . IT WAS FURTHER POINTED OUT BY THE LEARNED AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE THAT THE ISSUE ARISING IN ALL THE APPEALS WAS IDENTICAL I.E. ADJUSTMENT ON ACCOUNT O F ROYALTY PAYMENTS AND THERE WAS NO REASON FOR NOT FILING THIS APPEAL. THE PRESENT APPEAL WAS FILED ON 15.04.2014 AFTER DELAY OF 479 DAYS. THE LEARNED AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE PLACED RELIANCE ON THE RATIO LAID DOWN BY THE HONBLE SUPREM E COURT IN COLLECTOR, LAND ACQUISITION, ANANTNAG & ANR VS. MST. KATIJI & ORS. REPORTED IN 1987 AIR 1353 (SC). 5. THE LEARNED DEPARTMENTAL REPRESENTATIVE FOR THE REVENUE POINTED OUT THAT THE ASSESSEE HAD FAILED TO FURNISH THE APPEAL IN TIME. 6. ON PERUSAL OF THE RECORD, WE FIND MERIT IN THE CONTENTION OF THE ASSESSEE. THE DEFAULT IN FILING THE APPEAL LATE BEFORE THE TRIBUNAL MERITS TO BE CONDONED IN VIEW OF THE FACTS AND CIRCUMSTANCES, WHEREIN BECAUSE OF A MISTAKE, THE APPEAL FOR ASSESSMENT YEAR 2005 - 06 W AS FILED AFTER DELAY OF 479 DAYS. WE FIND SUPPORT FROM THE RATIO LAID DOWN BY THE HONBLE SUPREME COURT IN COLLECTOR, LAND ACQUISITION, ANANTNAG & ANR VS. MST. KATIJI & ORS. (SUPRA) . ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 5 7. NOW, COMING TO THE MERITS OF THE ISSUE RAISED BEFORE US. THE ISSUE IS IN RELATION TO THE ROYALTY PAYMENTS TO ASSOCIATE ENTERPRISES I.E. THE MANNER IN WHICH THE ROYALTY PAYMENTS NEEDS TO BE COMPUTED AND THE RATE OF ROYALTY TO BE ADOPTED FOR WORKING OUT THE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTION UNDERTAKEN BY THE A SSESSEE. IT WAS POINTED OUT BY THE LEARNED AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE THAT THE ASSESSING OFFICER WHILE BENCHMARKING THE INTERNATIONAL TRANSACTION HAD APPLIED CUP METHOD AS SIMILAR TRANSACTION WAS UNDERTAKEN BY ANOTHER CONCERN IN CHINA. ON THE OTHER HAND, THE ASSESSEE HAD APPLIED TNMM METHOD. IT WAS FURTHER POINTED OUT BY THE LEARNED AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE THAT SIMILAR ISSUE AROSE BEFORE THE TRIBUNAL IN VARIOUS YEARS AND THE TRIBUNAL VIDE SEPARATE ORDERS HAVE ALLOWED TH E CLAIM OF THE ASSESSEE IN RESPECT OF ROYALTY PAYMENTS. IN RESPECT OF SECOND ISSUE, THE MATTER HAS BEEN REMITTED BACK TO THE FILE OF ASSESSING OFFICER. 8 . THE LEARNED DEPARTMENTAL REPRESENTATIVE FOR THE REVENUE PLACED RELIANCE ON THE ORDER OF CIT(A). 9 . WE HAVE HEARD THE RIVAL CONTENTIONS AND PERUSED THE RECORD. THE ISSUE ARISING IN THE PRESENT APPEAL VIDE GROUNDS OF APPEAL NO.1.1 TO 1.3 IS IN RELATION TO THE BENCHMARKING OF INTERNATIONAL TRANSACTION OF ROYALTY PAYMENTS BY THE ASSESSEE TO ITS ASSOCIATE ENTERPRISES AND WHETHER THE SAME WAS AT ARM'S LENGTH PRICE. THE SAID ISSUE HAS ARISEN IN THE APPEALS STARTING FROM ASSESSMENT YEAR 2001 - 02 AND 2002 - 03 AND THEREAFTER, FROM ASSESSMENT YEARS 2006 - 07 TO 2009 - 10. THE ISSUE HAS BEEN ADJUDICATED BY THE TRIBUNA L BY SEPARATE ORDERS ON VARIOUS DATES AS ENUMERATED HEREUNDER: - ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 6 ASSESSMENT YEAR APPEAL NO. ITAT ORDER DATE 2001 - 02 1169/PN/2011 25/7/2014 2002 - 03 668/PN/2012 25/7/2014 2006 - 07 1477/PN/2010 11/2/2014 2007 - 08 1659/PN/2011 11/2/2014 2008 - 09 2181/PN/20 12 25/7/2014 2009 - 10 83/PN/2012 25/7/2014 1 0 . THE ASSESSEE HAD UNDERTAKEN CERTAIN INTERNATIONAL TRANSACTIONS WITH ITS ASSOCIATE ENTERPRISES, AGAINST WHICH REFERENCE WAS MADE BY THE ASSESSING OFFICER UNDER SECTION 92CA(1) OF THE ACT TO THE TPO. VIDE OR DER DATED 31.03.2008 , THE TPO PASSED AN ORDER UNDER SECTION 92CA(3) OF THE ACT PROPOSING AN ADJUSTMENT OF RS.64,78,990/ - ON ACCOUNT OF INTERNATIONAL TRANSACTIONS UNDERTAKEN BY THE ASSESSEE WITH ITS ASSOCIATE ENTERPRISES, BEING NOT AT ARM'S LENGTH PRICE. T HE ASSESSING OFFICER MADE A PROPOSAL UNDER SECTION 143(3) R.W.S. 144C(1) OF THE ACT, AGAINST WHICH THE ASSESSEE FILED OBJECTIONS BEFORE THE DRP, WHO IN TURN, DISMISSED THE SAID OBJECTIONS. THE ASSESSING OFFICER THEREAFTER, PASSED THE ASSESSMENT ORDER GIVI NG EFFECT TO SUCH DIRECTIONS. THE ASSESSEE HAD ENTERED INTO VARIOUS INTERNATIONAL TRANSACTIONS WITH ITS ASSOCIATE ENTERPRISES, WHICH WERE SEGREGATED BY THE ASSESSEE INTO TWO SEGMENTS AND WERE BENCHMARKED FOLLOWING TRANSACTIONAL NET MARGIN (TNM) METHOD. T HE TWO SEGMENTS SEGREGATED BY THE ASSESSEE WERE (I) MANUFACTURING SEGMENT - WHERE THE TRANSACTION S RELAT ING TO IMPORT OF RAW MATERIALS, EXPORT OF FINISHED GOODS AND PARTS, IMPORT OF BULK RAW MATERIAL GOODS FOR TRADING AND REPACKING AND PAYMENT OF ROYALTY H AD BEEN GROUPED; AND (II) MARKETING AND SALE SUPPORT SEGMENT WHERE THE VARIOUS MARKETING AND SALES SUPPORT ACTIVITIES WERE GROUPED, AND WERE SEPARATELY BENCHMARKED. THE ASSESSEE VIDE ITS TRANSFER PRICING STUDY CLAIMED THAT THE VALUE OF INTERNATIONAL TRA NSACTIONS WERE AT ARM'S LENGTH PRICE. THE TPO HOWEVER, DID NOT ACCEPT THE PLEA OF THE ASSESSEE TO SEGREGATE THE TRANSACTIONS OTHER THAN MARKETING AND ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 7 SALES SUPPORT SERVICES WHILE BENCHMARKING THE INTERNATIONAL TRANSACTIONS. AS PER THE TPO, EACH TRANSACTI ON WAS TO BE BENCHMARKED SEPARATELY AND THE GROUPING OF THE TRANSACTION IN ONE SEGMENT AND THEN BENCH MARKING THE SAME FOLLOWING TNMM METHOD, AS PER THE TPO, WAS NOT IN KEEPING WITH THE WORDS AND SPIRIT OF THE TNMM METHOD AND OECD GUIDELINES IN THIS REGARD. HENCE , THE TPO WAS OF THE VIEW THAT SUCH BENCHMARKING WAS NOT ACCEPTABLE. ANOTHER ASPECT NOTED BY THE TPO WAS THE RO YALTY PAYMENT MADE BY THE ASSESSEE TO ITS ASSOCIATE ENTERPRISES @ 5% OF THE DOMESTIC SALES AND 8% OF THE EXPORT SALES. THE FIRST ASPECT OF THE ISSUE WAS THE RATE AT WHICH THE SAID ROYALTY PAYMENT WAS TO BE MADE. AS PER DOCUMENTS SUBMITTED FOR THE ROYALTY PAYMENT, THE TPO NOTED THAT WHAT WAS APPROVED BY THE GOVERNMENT OF INDIA, MINISTRY OF COMMERCE AND INDUSTR IES , SECRETARIAT FOR INDUSTRIA L ASSISTANCE (SIA) , THAT THE RATES OF ROYALTY WERE APPROVED ON NET SALES SUBJECT TO TAXES. THE ASSESSEE WAS ASKED TO EXPLAIN THE MEANING OF THE SAME AND HOW THEY HAVE BEEN WORKED OUT. THE ASSESSEE WAS ALSO ASKED TO PRODUCE COMPLETE WORKING IN RESPECT O F ROYALTY PAID BOTH ON THE DOMESTIC SALES AND EXPORT SALES. THE TPO FURTHER NOTED FROM THE DETAILS FILED THAT THE ROYALTY HAD BEEN PAID ON THE TOTAL SALES REVENUE MINUS EXCISE DUTY AND AFTER EXCLUDING THE RECEIPT FROM SALE OF PRODUCT/INCOME ON WHICH ROYAL TY IS NOT PAYABLE. THE TPO WAS OF THE VIEW THAT WHERE THE PAYMENT OF ROYALTY WAS ATTRIBUTED TO USAGE OF TECHNICAL KNOW - HOW AND BRAND, ETC. , THEN THE SAME BECOMES PAYABLE ONLY TOWARDS THE VALUE ADDITION DONE BY ADOPTING SUCH TECHNICAL KNOW - HOW OR TECHNOLOG Y. THE TPO FURTHER PROPOSED ADJUSTMENT TO THE INTERNATIONAL TRANSACTION RELATING TO PAYMENT OF ROYALTY AND WAS OF THE VIEW THAT INTERNAL CUP METHOD CONSIDERING THE APPROVAL OF SIA IN ASSESSEES CASE AS BENCHMARKED WITH INTERPRETATION OF WORD NET SALES I S TO BE MADE. AS PER THE SAID WORKING, THE ARM'S LENGTH PRICE OF INTERNATIONAL TRANSACTION RELATING TO PAYMENT OF ROYALTY WAS TABULATED AND THE ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 8 TPO PROPOSED AN ADJUSTMENT OF RS.96,64,545/ - TO THE INTERNATIONAL TRANSACTION RELATING TO THE PAYMENT OF ROYALTY . THE ASSESSEE WAS SHOW CAUSED AND AFTER CONSIDERING THE REPLY OF THE ASSESSEE THAT TNMM METHOD WAS THE MOST APPROPRIATE METHOD FOR THE PURPOSE OF ASCERTAINING THE ARM'S LENGTH NATURE OF ASSESSEES TRANSACTION AND THE SPECIFIC CUP METHOD WAS NOT TO BE APP LIED FOR THE REASON OF ABSENCE OF APPROPRIATE COMPARABLE DATA TO APPLY, WAS REJECTED BY THE TPO AND OTHER OBJECTIONS RAISED BY THE ASSESSEE WERE ALSO REJECTED AND HE MADE AN ADJUSTMENT OF RS. 7,99,500/ - ON ACCOUNT OF INTERNATIONAL TRANSACTION RELATING TO EX PORT OF FINISHED GOODS TO ASSOCIATE ENTERPRISES AND RS.64,78,990/ - RELATING TO TRANSACTION OF PAYMENT OF ROYALTY. AGAINST THE ABOVE SAID, THE ASSESSING OFFICER AFTER REJECTION OF OBJECTIONS OF THE ASSESSEE BY THE DRP, MADE AN ADDITION UNDER SECTION 143(3) R.W.S. 144C OF THE ACT. 11. THE FIRST ISSUE ARISING BEFORE US IS WITH REGARD TO THE ADDITION MADE ON ACCOUNT OF INTERNATIONAL TRANSACTION OF PAYMENT OF ROYALTY TO THE ASSOCIATE ENTERPRISES AMOUNTING TO RS.64,78,990/ - . 12. WE FIND THAT SIMILAR ISSUE AR OSE BEFORE THE TRIBUNAL IN ASSESSEES OWN CASE RELATING TO ASSESSMENT YEAR 2006 - 07 AND VIDE ORDER DATED 11.02.2014, IT WAS HELD AS UNDER: - 7. THE FIRST SUBJECT - MATTER OF THE DISPUTE IS WITH REGARD TO AN ADDITION OF RS.91,66,061/ - MADE ON ACCOUNT OF INTERN ATIONAL TRANSACTION OF PAYMENT OF ROYALTY TO THE AE. THE APPELLANT HAS ASSAILED THE ACTION OF THE ASSESSING OFFICER ON THIS ASPECT, WITHOUT PREJUDICE TO ITS PRELIMINARILY GRIEVANCE THAT THE ADOPTION OF THE CUP METHOD FOR THE PURPOSES OF BENCHMARKING INTER NATIONAL TRANSACTION OF ROYALTY IS NOT JUSTIFIED INASMUCH AS THE ASSESSING OFFICER WAS WRONG IN REJECTING THE ASSESSEES APPROACH OF AGGREGATING SUCH TRANSACTION WITH THOSE OF MANUFACTURING SEGMENT AND THEREAFTER BENCHMARKING IT UNDER THE TNM METHOD. THE RELEVANT FACTS ARE THAT ASSESSEE HAS ENTERED INTO A TECHNICAL COLLABORATION AGREEMENT WITH M/S AKZO NOVEL B.V., NETHERLANDS (HEREINAFTER REFERRED TO AS THE AE), WHICH HAS BEEN APPROVED BY THE GOVT. OF INDIA, MINISTRY OF COMMERCE AND INDUSTRY, DEPARTMENT OF INDUSTRIAL POLICY AND ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 9 PROMOTION (SIA), NEW DELHI ON 11.02.2005 FOR A PERIOD OF SEVEN YEARS W.E.F. 19.12.2004. IN TERMS OF SUCH APPROVAL, ASSESSEE WAS AUTHORIZED TO PAY ROYALTY TO ITS AE I.E. M/S AKZO NOVEL CHEMICALS B.V., NETHERLANDS @ 5% ON DOMESTIC S ALES AND @ 8% ON EXPORT SALES. FURTHER, IN TERMS OF CLAUSE (8)(I) OF THE SAID APPROVAL, A COPY OF WHICH HAS BEEN PLACED IN THE PAPER BOOK AT PAGES 259 TO 261, ROYALTY PAYABLE IS REQUIRED TO BE CALCULATED IN ACCORDANCE WITH THE PROVISIONS OF FOREIGN EXCHAN GE CONTROL MANUAL OF RBI AND OTHER SUBSISTING INSTRUCTIONS OF THE GOVT. OF INDIA/RESERVE BANK OF INDIA. AS PER THE SAID APPROVAL, ASSESSEE COMPUTED THE ROYALTY OF RS.1,35,28,221/ - ON ITS DOMESTIC SALES, AND RS.81,28,514/ - ON ITS EXPORT SALES THEREBY TOTAL ING TO RS.2,60,56,735/ - . THE AFORESAID INTERNATIONAL TRANSACTION HAS NOT BEEN ACCEPTED BY THE TPO/ASSESSING OFFICER AS BEING AT AN ARMS LENGTH PRICE. PRIMARILY, THE AREAS OF DIFFERENCE BETWEEN THE ASSESSEE AND THE TPO, WHICH HAVE BEEN ARTICULATED BEFORE US BY THE APPELLANT, ARE TWO FOLD. FIRSTLY, AS PER THE TPO, THE COST OF CERTAIN RAW MATERIALS, WHICH ACCORDING TO HIM, ARE MERE CONSTITUENT MATERIAL NEED TO BE DEDUCTED FROM THE SALES VALUES TO ARRIVE AT NET SALES VALUE ON WHICH ROYALTY IS TO BE COMP UTED. THUS, AS PER THE TPO, ROYALTY HAS BEEN CALCULATED BY THE ASSESSEE IN EXCESS OF WHAT IS OTHERWISE WARRANTED. SECONDLY, AS PER THE TPO, THE ROYALTY PAID TO THE AE FOR EXPORT SALES @ 8% IS NOT AT AN ARMS LENGTH PRICE FOR REASON THAT ROYALTY PAID BY A NOTHER AKZO GROUP COMPANY I.E. TIANJIN AKZO NOBEL PEROXIDES, CHINA (HEREINAFTER REFERRED TO AS TANPC) TO THE SAME AE WAS @ 5%; AND, THEREFORE THE TPO ADOPTED THE RATE OF 5% TO DETERMINE THE ARMS LENGTH ROYALTY PAYABLE BY ASSESSEE TO THE AE ON THE EXPORT SALES. THE AFORESAID POSITION HAS SINCE BEEN AFFIRMED BY THE DRP ALSO. 8. ON BOTH THE AFORESAID ASPECTS, THE LEARNED COUNSEL FOR THE ASSESSEE VEHEMENTLY SUBMITTED THAT THE LOWER AUTHORITIES HAVE ERRED IN LAW AS WELL ON VEHEMENTLY SUBMITTED THAT THE LOWER AUTHORITIES HAVE ERRED IN LAW AS WELL ON FACTS. FIRSTLY, IT IS CONTENDED TH AT THE EXPRESSION NET SALES, WAS REQUIRED TO BE INTERPRETED IN TERMS OF THE STANDARD TERMS AND CONDITIONS PRESCRIBED BY THE RESERVE BANK OF INDIA, WHICH ARE APPLICABLE TO ALL AGREEMENTS PERTAINING TO ROYALTY PAYMENTS ON TECHNOLOGY TRANSFERS TO INDIAN COM PANIES. IN THIS REGARD, OUR ATTENTION WAS DRAWN TO THE MEANING OF EXPRESSION NET SALES PROVIDED IN PARA 3.3 OF CHAPTER III OF THE MANUAL FOR FOREIGN DIRECT INVESTMENT POLICY & PROCEDURES ISSUED BY DEPARTMENT OF INDUSTRIAL POLICY & PROMOTION, MINISTRY OF COMMERCE & INDUSTRY, GOVERNMENT OF INDIA, IN TERMS OF WHICH ONLY THE COST OF STANDARD BOUGHT - OUT COMPONENTS AND THE LANDED COST OF IMPORTED COMPONENTS WAS LIABLE TO BE REDUCED WHEREAS IN THE PRESENT CASE THE TPO HAS REDUCED THE COST OF CERTAIN RAW MATERIA LS BY TERMING THEM AS CONSTITUENT CHEMICALS, AN ACTION WHICH IS STATED TO BE INCONSISTENT WITH RELEVANT GOVERNMENT MANUALS. IT WAS ALSO POINTED OUT THAT THE COST SOUGHT TO BE REDUCED BY THE TPO WAS THE COST OF RAW MATERIALS, AND THE SAME COULD NOT BE EQUATED TO BOUGHT - OUT COMPONENTS. IT IS ALSO POINTED OUT THAT DURING THE PROCEEDINGS BEFORE THE LOWER AUTHORITIES, ASSESSEE HAD OBTAINED CLARIFICATIONS FROM THE DEPARTMENT OF INDUSTRIAL POLICY & PROMOTION, MINISTRY OF COMMERCE & INDUSTRY, GOVERNMENT OF INDIA IN THIS CONNECTION, COPIES OF WHICH HAVE BEEN PLACED IN THE PAPER BOOK AT PAGES 41 TO 45, WHICH CLEARLY SUGGEST THAT THE ACTION OF THE TPO WAS WRONG. THE LEARNED COUNSEL SUBMITTED THAT EVEN SUCH SPECIFIC CLARIFICATIONS OBTAINED FROM THE DEPARTMENT O F INDUSTRIAL POLICY & PROMOTION, GOVERNMENT OF INDIA HAVE BEEN IGNORED. ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 10 9. FURTHER, THE ADOPTION OF THE RATE OF 5% FOR ROYALTY PAYABLE ON EXPORT SALES TO DETERMINE THE ARMS LENGTH PRICE WAS ALSO ASSAILED ON THE GROUND THAT THE TRANSACTION OF ROYALTY PAY MENT BY TANPC, CHINA TO THE AE WAS NOT AN UNCONTROLLED COMPARABLE TRANSACTION. MOREOVER, IT WAS POINTED OUT THAT THE ROYALTY OF 5% PAID BY TANPC TO THE AE WAS SUBJECT TO CERTAIN REGULATORY RESTRICTIONS IN CHINA AND THEREFORE IN TERMS OF RULE 10B(2)(D) OF THE INCOME TAX RULES, 1962 (IN SHORT THE RULES) THE EXISTENCE OF SUCH GOVERNMENTAL RESTRICTION ARE REQUIRED TO BE CONSIDERED FOR THE PURPOSES OF DETERMINING THE COMPARABILITY OF A TRANSACTION. IT WAS, THUS, POINTED OUT THAT THE PAYMENT OF ROYALTY @ 5% B Y TANPC WAS NOT A COMPARABLE TRANSACTION. FURTHERMORE, IT IS POINTED OUT THAT THE TRANSACTION OF ROYALTY PAYMENT BY TANPC TO THE AE WAS A CONTROLLED TRANSACTION AND THEREFORE IT COULD NOT HAVE BEEN CONSIDERED AS A TRANSACTION FALLING WITHIN THE SCOPE OF C UP METHOD. IN SUPPORT OF SUCH PROPOSITION, RELIANCE HAS BEEN PLACED ON THE JUDGEMENT OF THE SKODA AUTO INDIA PVT. LTD.30 SOT 319 (PUNE). EVEN OTHERWISE IT IS SOUGHT TO BE MADE OUT BY REFERRING TO THE ROYALTY AGREEMENT BETWEEN ASSESSEE AND THE AE, THAT TH E SAME IS QUITE DIFFERENT FROM THE AGREEMENT BETWEEN THE CHINESE ENTITY TANPC AND THE AE, COPIES OF WHICH HAVE BEEN PLACED IN THE PAPER BOOK AT PAGES 376 TO 386 OF THE PAPER BOOK FOR ASSESSMENT YEAR 2006 - 07 AND AT PAGE 186 OF THE PAPER BOOK FOR ASSESSMENT YEAR 2007 - 08 RESPECTIVELY. IN THIS CONTEXT, IT IS SOUGHT TO BE MADE OUT THAT THE PERIOD OF THE AGREEMENT AND THE PRODUCTS COVERED ARE DIFFERENT INASMUCH AS THE INDIAN AGREEMENT IS FOR SEVEN (7) YEARS WHEREAS THE CHINAS AGREEMENT IS FOR TWENTY (20) YEARS. THE PRODUCTS COVERED UNDER THE TWO AGREEMENTS ARE ALSO DIFFERENT INASMUCH AS THE INDIAN AGREEMENT HAS 22 PRODUCTS WHEREAS CHINAS AGREEMENT HAS 33 PRODUCTS. IT IS SUBMITTED THAT WHERE THE PERIOD AND THE PRODUCTS COVERED ARE DIFFERENT, SUCH TRANSACTIONS CANNOT BE CONSIDERED AS COMPARABLE AND REFERENCE HAS BEEN MADE TO THE CANNOT BE CONSIDERED AS COMPARABLE AND REFERENCE HAS BEEN MADE TO THE DECISION OF THE PUNE BENCH OF THE TRIBUNAL IN THE CASE OF KIRLOSKAR EBARA PUMPS LTD. 47 SOT 20 (PUNE) IN THIS REGARD. THIRDLY, IT IS SOUGHT TO BE MADE OUT THAT THERE IS AN ERROR IN THE ADDITION MADE ON ACCOUNT OF ROYALTY INASMUCH AS A SUM OF RS.3,07,170/ - HAS BEEN ADDED IN EXCESS, EVEN IF THE STAND OF THE TPO WAS LIABLE TO BE UPHELD. 10. ON THE OTHER HAND, THE LEARNED CIT(DR) APPEARING FOR THE REVENUE HAS REFERRED TO THE ORDERS OF THE AU THORITIES BELOW IN SUPPORT OF THE CASE OF THE REVENUE. THE LEARNED CIT(DR) SUBMITTED THAT THE METHODOLOGY ADOPTED BY THE ASSESSEE FOR COMPUTING ROYALTY PAYABLE TO ITS AE WAS CORRECTLY REJECTED BY THE TPO AND IN THIS CONTEXT A REFERENCE HAS BEEN MADE TO PA RA 8.3 OF THE ORDER OF THE TPO. IT WAS EMPHASIZED THAT FOR MANUFACTURING THE SPECIALITY CHEMICALS, ASSESSEE WAS USING HYDROGEN PEROXIDE AND HYDROPEROXIDE, CHOLORFORMATE AND CHLORIDE, CATALYST AND OTHERS WHICH WERE MERE CONSTITUENT CHEMICALS AND NOT RAW MATERIALS. ACCORDING TO THE REVENUE, THESE CONSTITUENT CHEMICALS ARE EQUIVALENT TO THE EXPRESSION BOUGHT - OUT COMPONENTS OR IMPORTED COMPONENTS WHICH ARE REQUIRED TO BE REDUCED FROM THE GROSS VALUE OF SALES BEFORE COMPUTING THE AMOUNT OF ROYALTY PAYA BLE. JUSTIFYING THE CONSIDERATION OF SUCH CHEMICALS AS MERE CONSTITUENT CHEMICALS IT WAS POINTED OUT THAT SUCH CHEMICALS ARE NOT MANUFACTURED BY THE ASSESSEE FROM THEIR BASIC RAW MATERIALS AND THE SAME BEING MERELY CONSTITUENT CHEMICALS, THERE IS NO V ALUE ADDITION ON THESE MATERIAL IN THE MANUFACTURING PROCESS; THUS, THE SAME ARE EXCLUDIBLE FROM THE VALUE OF SALES TO COMPUTE THE AMOUNT OF ROYALTY PAYABLE. IN THIS MANNER, THE DETERMINATION OF THE FIGURE OF NET SALE BY THE TPO FOR THE PURPOSE ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 11 OF COMPU TATION OF ROYALTY PAYABLE HAS BEEN DEFENDED. THE ADOPTION OF THE RATE OF 5% ON EXPORT SALES FOR PAYMENT OF ROYALTY AS AGAINST 8% ADOPTED BY THE ASSESSEE, HAS ALSO BEEN DEFENDED. IN THIS REGARD A REFERENCE HAS BEEN MADE TO PARA 1.70 OF THE OECD GUIDELINES TO JUSTIFY THE ADOPTION OF THE TRANSACTION OF ROYALTY PAYMENT BY TANPC TO THE AE AS A COMPARABLE TRANSACTION FOR THE PURPOSES OF COMPARABILITY ANALYSIS. ACCORDING TO THE LEARNED CIT(DR), THE AFORESAID GUIDELINE OF OECD SUGGESTS THAT USEFUL INFORMATION CO ULD NOT BE IGNORED BY APPLYING STRICT STANDARDS OF COMPARABILITY AND EVEN EVIDENCE FROM THE ENTERPRISES ENGAGED IN CONTROLLED TRANSACTIONS WITH ASSOCIATED ENTERPRISES MAY ALSO BE USEFUL IN CARRYING OUT THE COMPARABILITY ANALYSIS. IT WAS, THEREFORE, CONTEN DED THAT THE APPLICATION OF A RATE OF 5% FOR PAYMENT OF ROYALTY ON EXPORT SALE BASED THE TRANSACTION OF ROYALTY PAYMENT BY TANPC TO THE AE, WAS JUSTIFIED UNDER THE CUP METHOD. A REFERENCE HAS ALSO BEEN MADE TO THE DISCUSSION MADE BY THE DRP IN THIS REGARD WHEREIN IT IS SOUGHT TO BE STATED THAT THE TRANSACTION ON ROYALTY PAYMENT BY TANPC TO ITS AE @ 5% WAS A PERFECT COMPARABLE WHILE APPLYING THE CUP METHOD AND THUS THE ACTION OF THE TPO IS SOUGHT TO BE JUSTIFIED. 11. WE HAVE CAREFULLY CONSIDERED THE RIVAL S UBMISSIONS ON THIS ASPECT. BEFORE PROCEEDING TO ADJUDICATE THE ADDITION OF RS. 91,66,061/ - MADE ON ACCOUNT OF ROYALTY PAYMENT, IT WOULD BE RELEVANT TO NOTE THE PERTINENT FACTS. THE APPELLANT COMPANY IS PAYING ROYALTY TO THE AE FOR TRANSFER OF TECHNOLOGY IN TERMS OF A FOREIGN TECHNOLOGY COLLABORATION AGREEMENT, WHICH HAS BEEN DULY APPROVED BY THE GOVERNMENT OF INDIA, A COPY OF SUCH AGREEMENT IS PLACED AT PAGES 259 TO 261 OF THE PAPER BOOK. IN TERMS OF THE SAID AGREEMENT, ROYALTY PAYMENTS ARE AUTHORIZED ON DOMESTIC SALES AND ON EXPORT SALES @ 5% AND 8% RESPECTIVELY OF NET SALES, SUBJECT TO TAXES. THE ITEMS OF MANUFACTURE COVERED BY THE FOREIGN COLLABORATION ARE POLYMERIZATION INITIATORS, WHICH IS A PRODUCT BY THE FOREIGN COLLABORATION ARE POLYMERIZATION INITIATORS, WHICH IS A PRODUCT MANUFACTURED BY THE ASSESSEE FOR USE AS CATALY ST IN MANUFACTURING OF POLYMERS. THE APPROVAL PRESCRIBES THAT THE ROYALTY PAYABLE SHALL BE CALCULATED IN ACCORDANCE WITH THE PROVISIONS OF THE FOREIGN EXCHANGE CONTROL MANUAL OF RBI AND OTHER SUBSISTING INSTRUCTIONS OF GOVT. OF INDIA/RESERVE BANK OF INDIA . IN THIS CONTEXT, A REFERENCE HAS BEEN MADE TO THE CHAPTER III OF THE MANUAL FOR FOREIGN DIRECT INVESTMENT ISSUED BY DEPARTMENT OF INDUSTRIAL POLICY AND PROMOTION, GOVT. OF INDIA WHICH CONTAINS, INTER - ALIA, THE POLICY & PROCEDURES CONCERNING THE FOREIGN TECHNOLOGY AGREEMENTS. IN PARA 3.3, IT IS PRESCRIBED THAT THE ROYALTY PAYMENTS FOR FOREIGN TECHNOLOGY COLLABORATION BY INDIAN COMPANIES ARE LIMITED TO CERTAIN PERCENTAGE OF SALES AND ARE NET OF TAXES AND ARE CALCULATED ACCORDING TO STANDARD CONDITIONS. IT IS FURTHER PRESCRIBED THAT THE ROYALTY IS TO BE CALCULATED ON THE BASIS OF NET EX - FACTORY SALE PRICE OF THE PRODUCT, EXCLUSIVE OF EXCISE DUTIES, MINUS THE COST OF THE STANDARD BOUGHT - OUT COMPONENTS AND THE LANDED COST OF IMPORTED COMPONENTS, IRRESPECT IVE OF THE SOURCE OF PROCUREMENT, INCLUDING OCEAN FREIGHT, INSURANCE, CUSTOM DUTIES, ETC. THE FIRST BONE OF CONTENTION BETWEEN THE ASSESSEE AND THE REVENUE IS WITH REGARD TO THE BASIS, ON WHICH THE ROYALTY IS PAYABLE. AS PER THE APPELLANT, THE AMOUNT OF ROYALTY PAYABLE CALCULATED BY IT IS IN LINE WITH THE APPLICABLE INSTRUCTIONS OF THE GOVT. OF INDIA AND/OR RBI. THE REVENUE, ON THE OTHER HAND, CONTENDS THAT CERTAIN CHEMICALS USED IN THE MANUFACTURING PROCESS, BEING HYDROGEN PEROXIDE AND HYDROPEROXIDE, C HOLORFORMATE AND CHLORIDE, CATALYST AND OTHERS AMOUNTING TO RS.21,34,016/ - ARE MERE CONSTITUENT CHEMICALS, AND COST OF THE SAME IS TO BE REDUCED ON PRO RATA BASIS FROM THE FIGURE OF DOMESTIC ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 12 SALES AND EXPORT SALES AND ONLY ON THE REMAINING AMOUNT OF N ET SALES ROYALTY PAYABLE IS TO BE CALCULATED. THE CLAIM OF THE ASSESSEE IS THAT SUCH CHEMICALS ARE INDEED RAW MATERIALS USED BY THE ASSESSEE IN ITS MANUFACTURING PROCESS, AND FOR THE PURPOSE OF COMPUTING ROYALTY PAYABLE IN TERMS OF FOREIGN TECHNOLOGY COL LABORATION AGREEMENT, COST OF RAW MATERIAL IS NOT PRESCRIBED AS A DEDUCTIBLE ITEM IN ORDER TO CALCULATE NET SALES. THEREFORE, WHILE CALCULATING THE ROYALTY PAYABLE, ASSESSEE HAS NOT REDUCED THE COST OF ANY OF THE RAW MATERIALS CONSUMED. THE ASSESSEE HA S COMPUTED ROYALTY PAYABLE WITH REFERENCE TO SALES OF RS.37,21,70,846/ - WHILE THE TPO HAS DONE SO WITH REFERENCE TO SALES OF RS.24,98,13,470/ - . BE THAT AS IT MAY, THE FIRST POINT OF DIFFERENCE IS MEANING OF THE EXPRESSION NET SALES, BECAUSE THE ROYALTY PAYABLE IS TO BE CALCULATED ON THE NET SALES, SUBJECT TO TAXES, AS PER THE APPROVAL OF GOVT. OF INDIA. 12. BEFORE WE PROCEED FURTHER ON THIS ASPECT, IT WOULD BE APPROPRIATE TO REFER TO A PERTINENT POINT ASSERTED BY THE APPELLANT, WHICH IS TO THE EFFEC T THAT THE AMOUNT OF ROYALTY REMITTED TO THE FOREIGN COLLABORATION, I.E. THE AE, IS AS PER THE PROVISIONS OF FOREIGN EXCHANGE CONTROL MANUAL OF RBI. NOTABLY, THE APPROVAL BY THE DEPARTMENT OF INDUSTRIAL POLICY & PROMOTION (SECRETARIAT FOR INDUSTRIAL ASSIS TANCE) DATED 11.02.2005 ITSELF PRESCRIBES THAT ROYALTY SHALL BE PAYABLE IN ACCORDANCE WITH THE PROVISIONS OF FOREIGN EXCHANGE CONTROL MANUAL OF RBI AND OTHER SUBSISTING INSTRUCTIONS OF THE GOVT. OF INDIA/RESERVE BANK OF INDIA. THERE IS NO MATERIAL ON RECO RD TO SUGGEST THAT THE CALCULATION OF ROYALTY MADE BY THE ASSESSEE HAS BEEN FOUND TO BE VIOLATIVE OF THE RESPECTIVE PROVISIONS OF FEMA OR OTHER SUBSISTING INSTRUCTIONS OF THE GOVT. OF INDIA/RESERVE BANK OF INDIA. IN THIS BACKGROUND, A MOOT QUESTION WHICH ARISES IS WHETHER THE TPO IS COMPETENT TO REWORK THE ROYALTY PAYMENT ON THE BASIS OF HIS INTERPRETATION OF THE MEANING OF EXPRESSION NET SALES, FOR THE PURPOSE OF HIS INTERPRETATION OF THE MEANING OF EXPRESSION NET SALES, FOR THE PURPOSE OF DETERMINING ITS ARMS LENGTH PRICE UNDER THE CUP METHOD. 13. IN OUR CONSIDERED OPINI ON, THE ACTION OF THE TPO IN RE - WORKING THE AMOUNT OF ROYALTY PAYABLE BASED ON HIS INTERPRETATION OF THE EXPRESSION NET SALES FOR THE PURPOSES OF DETERMINING ITS ARMS LENGTH PRICE IS NOT A RIGHT DECISION. THE TPO WAS EXPECTED TO EXAMINE THE INTERNATION AL TRANSACTION OF ROYALTY PAYMENT AS HE ACTUALLY FOUND IT OR IN OTHER WORDS, AS IT WAS TRANSACTED BETWEEN THE PARTIES; AND, THEN MAKE SUITABLE ADJUSTMENTS, IF REQUIRED, IN ORDER TO DETERMINE ITS ARMS LENGTH PRICE, BUT IT WAS IMPERMISSIBLE FOR HIM TO RE - WO RK OR RE - CAST THE TRANSACTION BASED ON HIS OWN UNDERSTANDING OF THE TERMS AND CONDITIONS OF AGREEMENT UNDERLYING THE TRANSACTION. WE SAY SO IN THE BACKGROUND OF THE FACT THAT THE TERMS AND CONDITIONS OF THE AGREEMENT ON THE BASIS OF WHICH ASSESSEE HAS COM PUTED THE ROYALTY PAYABLE HAS BEEN APPROVED BY THE GOVT. OF INDIA; AND, IT IS MANDATED THAT THE CALCULATIONS OF ROYALTY ARE SUBJECT TO THE RELEVANT PROVISIONS OF FOREIGN EXCHANGE CONTROL MANUAL OF RBI AND OTHER INSTRUCTIONS OF THE GOVT. OF INDIA/RESERVE BA NK OF INDIA. NOTABLY, THERE IS NO MATERIAL TO SUGGEST THAT THE AMOUNT OF ROYALTY CALCULATED BY THE ASSESSEE HAVE BEEN FAULTED BY ANY STATUTORY AUTHORITY FOR BEING INCONSISTENT WITH THE FOREIGN EXCHANGE CONTROL MANUAL OF RBI OR ANY OTHER SUBSISTING INSTRUC TIONS OF THE GOVT. OF INDIA/RESERVE BANK OF INDIA. RATHER THE AFORESAID ASSERTION OF THE ASSESSEE, HAS BEEN REJECTED BY THE TPO ON THE BASIS OF HIS OWN SUBJECTIVE INTERPRETATION OF THE EXPRESSION NET SALES. ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 13 14. AT THIS STAGE, WE MAY REFER TO THE JUDGMEN T OF THE HONBLE DELHI HIGH COURT IN THE CASE OF CIT VS. EKL APPLIANCES LTD. (2012) 345 ITR 241 (DEL). IN THE SAID CASE, ASSESSEE HAD ENTERED INTO AN INTERNATIONAL TRANSACTION BY WAY OF PAYMENT OF BRAND FEE/ROYALTY TO ITS ASSOCIATED ENTERPRISE UNDER AN AG REEMENT. THE REVENUE WAS REQUIRED TO DETERMINE THE ARMS LENGTH PRICE OF THE TRANSACTION. WHILE DOING SO, THE TPO NOTICED THAT ASSESSEE HAS BEEN INCURRING LOSSES YEAR AFTER YEAR, AND CONSIDERING SUCH PERPETUAL LOSSES THE TPO HELD THAT THE PAYMENT OF ROYA LTY DID NOT APPEAR JUSTIFIED AS THE TECHNICAL KNOWHOW/BRAND FEE AGREEMENT WITH THE ASSOCIATED ENTERPRISE HAD NOT BENEFITED THE ASSESSEE IN ACHIEVING PROFITS FROM ITS OPERATIONS. FOR THE SAID REASON, THE TPO HELD THAT THE BRAND FEE PAYMENT MADE BY THE ASSE SSEE TO THE ASSOCIATED ENTERPRISE WAS UNJUSTIFIED AND THE ARMS LENGTH PRICE OF THE TRANSACTION SHOULD BE TAKEN AS NIL. THE HONBLE HIGH COURT DISAPPROVED THE ACTION OF THE TPO, AND AFTER REFERRING TO THE OECDS TRANSFER PRICING GUIDELINES OBSERVED THAT THE TPO WAS EXPECTED TO EXAMINE THE INTERNATIONAL TRANSACTIONS AS HE ACTUALLY FOUND THEM. IN OUR CONSIDERED OPINION, THE AFORESAID PARITY OF REASONING LAID DOWN BY THE HONBLE DELHI HIGH COMES INTO PLAY IN THE PRESENT FACT - SITUATION ALSO, AS OUR FOLLOWIN G DISCUSSION WOULD SHOW. 15. IN THE CASE BEFORE THE HONBLE DELHI HIGH COURT, THE TPO HAD APPLIED THE CUP METHOD WHILE EXAMINING THE PAYMENT OF BRAND FEE/ROYALTY, WHICH ALSO IS THE POSITION IN THE CASE BEFORE US. THE HONBLE HIGH COURT REFERRED TO THE OEC DS TRANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES AND TAX ADMINISTRATIONS, AND REPRODUCED PARAS 1.36 TO 1.41 OF SUCH GUIDELINES, WHICH PROVIDE FOR RECOGNITION OF THE ACTUAL TRANSACTIONS UNDERTAKEN. THEREAFTER, THE HONBLE HIGH COURT OPINED AS UNDER : - 17. THE SIGNIFICANCE OF THE AFORESAID GUIDELINES LIES IN THE FACT THAT 17. THE SIGNIFICANCE OF THE AFORESAID GUIDELINES LIES IN THE FACT THAT THEY RECOGNISE THAT BARRING EXCEPTIONAL CASES, THE TAX ADMINISTRATION SHOULD NOT DISREGARD THE ACTUAL TRANSACTION OR SUBSTITUTE OTHER TRANSACTIONS FOR THEM AND THE EXAMINA TION OF A CONTROLLED TRANSACTION SHOULD ORDINARILY BE BASED ON THE TRANSACTION AS IT HAS BEEN ACTUALLY UNDERTAKEN AND STRUCTURED BY THE ASSOCIATED ENTERPRISES. IT IS OF FURTHER SIGNIFICANCE THAT THE GUIDELINES DISCOURAGE RESTRUCTURING OF LEGITIMATE BUSINES S TRANSACTIONS. THE REASON FOR CHARACTERISATION OF SUCH RESTRUCTURING AS AN ARBITRARY EXERCISE, AS GIVEN IN THE GUIDELINES, IS THAT IT HAS THE POTENTIAL TO CREATE DOUBLE TAXATION IF THE OTHER TAX ADMINISTRATION DOES NOT SHARE THE SAME VIEW AS TO HOW THE TR ANSACTION SHOULD BE STRUCTURED. 18. TWO EXCEPTIONS HAVE BEEN ALLOWED TO THE AFORESAID PRINCIPLE AND THEY ARE (I) WHERE THE ECONOMIC SUBSTANCE OF A TRANSACTION DIFFERS FROM ITS FORM; AND (II) WHERE THE FORM AND SUBSTANCE OF THE TRANSACTION ARE THE SAME BUT ARRANGEMENTS MADE IN RELATION TO THE TRANSACTION, VIE WED IN THEIR TOTALITY, DIFFER FROM THOSE WHICH WOULD HAVE BEEN ADOPTED BY INDEPENDENT ENTERPRISES BEHAVING IN A COMMERCIALLY RATIONAL MANNER. 16. FROM THE AFORESAID, IT FOLLOWS THAT THE EXAMINATION OF A CONTROLLED TRANSACTION SHOULD ORDINARILY BE BASED ON THE TRANSACTION AS IT HAS BEEN ACTUALLY UNDERTAKEN AND STRUCTURED BY THE ASSOCIATED ENTERPRISES. THUS, THE TPO SHOULD NOT DISREGARD THE ACTUAL TRANSACTION OR SUBSTITUTE OTHER TRANSACTIONS ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 14 FOR THEM. TH E TWO EXCEPTIONS WHICH HAVE BEEN PRESCRIBED ARE (I) WHERE THE ECONOMIC SUBSTANCE DIFFERS FROM ITS FORM; AND, (II) WHERE THE FORM AND SUBSTANCE OF THE TRANSACTION IS THE SAME BUT ARRANGEMENTS MADE IN RELATION TO THE TRANSACTION, VIEWED IN ITS TOTALITY, DIFF ER FROM THOSE WHICH WOULD HAVE BEEN ADOPTED BY INDEPENDENT ENTERPRISES BEHAVING IN A COMMERCIALLY RATIONAL MANNER. NOW, COMING BACK TO THE FACT - SITUATION OF THE PRESENT CASE. IN THIS CASE, THE TPO HAS REWORKED THE ROYALTY PAYABLE BY THE ASSESSEE TO ITS A E ON THE BASIS OF HIS INTERPRETATION OF THE EXPRESSION NET SALES FOR THE PURPOSES OF DETERMINING ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION OF ROYALTY PAYMENT TO THE AE, WHILE APPLYING THE CUP METHOD. THE MOOT POINT TO BE CONSIDERED IS WHETHER THE ACTION OF THE TPO IN INTERPRETING THE EXPRESSION NET SALES, CONTAINED IN THE FOREIGN TECHNOLOGY COLLABORATION AGREEMENT APPROVED BY THE GOVT. OF INDIA, DIFFERENTLY FROM WHAT HAS BEEN UNDERSTOOD BY THE ASSESSEE IS JUSTIFIED AND FALLS WITHIN THE EXCEPT IONS PROVIDED IN THE OECD GUIDELINES WHICH PERMIT THE TPO TO RE - WRITE THE TRANSACTION OR TO DISREGARD ACTUAL TRANSACTIONS. CONSIDERED IN THE CONTEXT OF THE OECD GUIDELINES WHICH HAVE BEEN EXHAUSTIVELY REFERRED BY THE HONBLE DELHI HIGH COURT IN THE CASE O F EKL APPLIANCES LTD. (SUPRA) THE IMPUGNED SITUATION DOES NOT FIT INTO THE TWO EXCEPTIONS. FIRSTLY, NEITHER THE REVENUE HAS ALLEGED AND NOR IS THERE ANY MATERIAL ON RECORD TO SUGGEST THAT THE ECONOMIC SUBSTANCE OF THE IMPUGNED TRANSACTION DIFFERS FROM ITS FORM. SECONDLY, THERE IS NO MATERIAL ON RECORD TO SUGGEST THAT THERE IS AN ARRANGEMENT BETWEEN ASSESSEE AND THE AE MADE IN RELATION TO THE IMPUGNED TRANSACTION WHICH WOULD DIFFER FROM THOSE WHICH WOULD HAVE BEEN ADOPTED BY INDEPENDENT ENTERPRISES BEHAVIN G IN A COMMERCIALLY RATIONAL MANNER. WE SAY SO FOR THE REASON THAT THE ENTIRE GAMUT OF ROYALTY PAYMENT BY THE ASSESSEE TO THE AE IS IN TERMS OF THE FOREIGN TECHNOLOGY COLLABORATION AGREEMENT, WHICH IS DULY APPROVED BY GOVT. OF INDIA IN TERMS OF COLLABORATION AGREEMENT, WHICH IS DULY APPROVED BY GOVT. OF INDIA IN TERMS OF ITS POLICY , WHICH IS APPLICABLE ACROSS THE SPECTRUM. MOREOVER, IT IS NOT THE CASE OF THE TPO OR EVEN OF THE REVENUE BEFORE US THAT THE ROYALTY REMITTED BY THE ASSESSEE TO THE AE HAS BEEN FOUND TO BE INCONSISTENT OR VIOLATIVE OF THE RESPECTIVE GOVERNMENT OR RBI GUID ELINES OR ANY OTHER AUTHORITY IN LAW. THUS, THE TPO ERRED IN CALCULATING ROYALTY PAYABLE ON SALES OF RS.24,98,13,475/ - AS AGAINST RS.37,21,70,846/ - CONSIDERED BY THE ASSESSEE FOR THE PURPOSE OF DETERMINING ITS ARMS LENGTH PRICE. 17. EVEN OTHERWISE, THE ACTION OF THE TPO IN CONSIDERING CERTAIN RAW MATERIALS USED IN THE PRODUCTION PROCESS AS MERE CONSTITUENT CHEMICALS AND EQUATING IT TO STANDARD BOUGHT - OUT COMPONENTS SO AS TO REDUCE THE COST OF SUCH MATERIAL FROM THE SALES FOR THE PURPOSES OF COMPUTING N ET SALES ELIGIBLE FOR ROYALTY PAYMENT, IS WITHOUT ANY COGENT BASIS. AT THE TIME OF HEARING, ASSESSEE WAS ASKED TO EXPLAIN ITS MANUFACTURING PROCESS AND IN RESPONSE A NOTE WAS FURNISHED EXPLAINING THE PROCESS UNDERTAKEN AND THE MATERIALS USED, WHICH IS REP RODUCED HEREIN : - PROCESS : THE MANUFACTURING PROCESS IS DESIGNED BY THE PARENT COMPANY FOR UTMOST SAFE OPERATIONS AND ALL THE NECESSARY PROCESS SAFETY INTERLOCKS AND SYSTEMS ARE DESIGNED AND VERIFIED BY THE PARENT COMPANY. THE RAW MATERIALS LIKE HYDROGEN PEROXIDE ARE REACTED AT CERTAIN PROCESS STAGES WITH RECOMMENDED PROCESS PARAMETERS (LIKE FLOW RATES, TEMPERATURE, PH ETC) TO FORM ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 15 AN INTERMEDIATE (SAY, NA2O2) AND THE SAME IS FURTHER REACTED WITH THE KEY RAW MATERIAL, NAMELY CHLOROFORMATES. THIS REACTION GIVES A MOLECULE OF CRUDE PRODUCT (I.E. PEROXIDE WHICH CONTAINS WEAK OXYGEN BOND). TO GET FURTHER CONVERSION, POST REACTION TIME IS ALLOWED. THIS CRUDE PRODUCT IS FURTHER PURIFIED AND DILUTED TO GET THE NECESSARY PURITY. NO SIDE PRODUCTS ARE FORMED IN THE PROCESS. A DIAGRAMMATIC FLOW CHART AND SIMPLIFIED VERSION OF PROCESS AND CHEMICAL REACTIONS IS ATTACHED HEREWITH. TECHNOLOGY : THE PROCESS KNOW HOW IS OWNED BY AKZO NOBEL. THE TECHNOLOGY USED FOR HIGHER CONVERSION AND SAFE OPERATION IS 'SIMULTANEOUS DOSING ' PROCESS OF MANUFACTURING. THIS DESCRIBES IMPORTANT PARAMETERS LIKE THE QUALITY OF RAW MATERIALS TO BE USED, SEQUENCE OF DOSING RAW MATERIALS, THEIR RATIOS, FLOWRATES, AND TIME ALLOWED FOR REACTIONS, MIXING REQUIREMENTS, SEPARATION TECHNIQUES PURIFYING ST AGES ETC. THE R & D OF PARENT COMPANY ALWAYS SUGGESTS FURTHER IMPROVEMENTS IN PROCESS FOR BETTER CONVERSIONS AND STABILITY OF THE FINISHED GOODS. THE MATERIAL OF CONSTRUCTION FOR REACTORS, CONCENTRATION OF RAW MATERIALS, IN - PROCESS CHECKS ARE THE OTHER KEY FACTORS REACTION : THE REACTION IS IRREVERSIBLE IN NATURE. ONLY THERMAL DECOMPOSITION IS POSSIBLE. DECOMPOSITION : THE PRODUCT CAN DECOMPOSE AT CERTAIN TEMPERATURE. SUCH DECOMPOSITION CAN PRODUCE PRODUCTS LIKE CARBON DIOXIDE (CO2), CARBON MONOXIDE AND 2 - E THYLHEXANOL. HOWEVER NONE OF THE ORIGINAL RAW MATERIALS LIKE HYDROGEN PEROXIDE OR CHLOROFORMATES CAN BE RETRIEVED. 18. FURTHER, THE DIFFERENCE BETWEEN THE KEY RAW MATERIAL AND THE FINISHED GOODS HAVE ALSO BEEN BROUGHT OUT AS FOLLOWS : - CRITERIA CHLOROFOR MATE FINISHED GOOD STORAGE CONDITIONS MISCIBLE/REACTIVITY IN WATER PURITY APPLICATION APPEARANCE HAZARD CLASS AMBIENT IMMISCIBLE WITH WATER AND REACTS 98% TO MANUFACTURE ORGANIC CHEMICALS CLEAR LIQUID TOXIC (6.1) - 15 DEG C MAX MISCIBLE WITH WATER 50 TO 60 % INITIATOR TO PVC POLYMERIZATION WHITE EMULSION OXIDISING AGENT (5.2) 19. ON THE BASIS OF THE ABOVE, IT WAS SOUGHT TO BE CANVASSED THAT THE CHEMICALS SOUGHT TO BE CLASSIFIED BY THE TPO AS CONSTITUENT MATERIAL ARE INDEED RAW MATERIALS. IT IS CANVASSED T HAT THE RAW MATERIALS USED BY THE ASSESSEE IN ITS PRODUCTION PROCESS INCLUDING THE SO - CALLED CONSTITUENT ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 16 CHEMICALS CLASSIFIED BY THE TPO, UNDERGO A CHEMICAL REACTION IN THE MANUFACTURING PROCESS, WHICH IS IRREVERSIBLE. IT IS FURTHER EXPLAINED THAT THE P ROPERTIES AND USAGE OF THE FINISHED GOODS ACHIEVED, NAMELY, POLYMERIZATION INITIATORS, IS QUITE, DISTINCT FROM THE RAW MATERIALS CONSUMED AND NONE OF THE RAW MATERIALS, INCLUDING THE SO - CALLED CONSTITUENT CHEMICALS USED IN THE MANUFACTURE OF FINISHED GOO DS, CAN BE RETRIEVED AFTER THE END OF THE MANUFACTURING PROCESS. 20. THE EFFORT OF THE TPO TO CLASSIFY CERTAIN INPUT MATERIAL AS CONSTITUENT CHEMICALS (INSTEAD OF RAW MATERIAL) AND EQUATE IT TO STANDARD BOUGHT - OUT COMPONENTS IS BECAUSE OF THE FOLLOWI NG STATEMENT CONTAINED IN THE MANUAL FOR FOREIGN DIRECT INVESTMENT POLICY & PROCEDURES ISSUED BY DEPARTMENT OF INDUSTRIAL POLICY & PROMOTION, GOVT. OF INDIA : - THE ROYALTY WILL BE CALCULATED ON THE BASIS OF THE NEXT EX - FACTORY SALE PRICE OF THE PRODUCT, E XCLUSIVE OF EXCISE DUTIES, MINUS THE COST OF THE STANDARD BOUGHT - OUT COMPONENTS AND THE LANDED COST OF IMPORTED COMPONENTS, IRRESPECTIVE OF THE SOURCE OF PROCUREMENT, INCLUDING OCEAN FRIGHT, INSURANCE, CUSTOM DUTIES, ETC. 21. IN TERMS OF THE AFORESAID, AP ART FROM OTHER SUMS THE COST OF THE STANDARD BOUGHT - OUT COMPONENTS AND THE LANDED COST OF IMPORTED COMPONENTS IS TO BE REDUCED FROM THE SALE PRICE OF THE PRODUCT IN ORDER TO CALCULATE THE ROYALTY PAYABLE. AS PER THE TPO, CERTAIN MATERIAL USED IN THE P RODUCTION PROCESS, NAMELY, HYDROGEN PEROXIDE AND HYDROPEROXIDE, CHOLORFORMATE AND CHLORIDE, CATALYST AND OTHERS ARE NOT MANUFACTURED BY THE ASSESSEE FROM THEIR BASIC RAW MATERIALS AND THE SAME BEING MERELY CONSTITUENT CHEMICALS, THERE IS NO VALUE ADDITIO N ON THESE MATERIAL IN THE MANUFACTURING PROCESS; THUS, THE SAME ARE EXCLUDIBLE FROM THE VALUE OF SALES TO MANUFACTURING PROCESS; THUS, THE SAME ARE EXCLUDIBLE FROM THE VALUE OF SALES TO COMPUTE THE AMOUNT OF ROYALTY PAYABLE. 22. IN THIS CONTEXT, WE HAVE PERUSED THE CLARIFICATION ISSUED BY MINISTRY OF COMMERCE & INDUSTRY (DEPARTMENT O F INDUSTRIAL POLICY & PROMOTION) TO SOME OF THE QUERIES PUT BY THE ASSESSEE, COPIES OF THE SAME HAVE BEEN PLACED IN THE PAPER BOOK AT PAGES 41 TO 45. WE ARE TEMPTED TO REPRODUCE HEREINAFTER THE FOLLOWING RELEVANT EXTRACT OF THE CLARIFICATION ON COMPUTATION OF ROYALTY : - MINISTRY OF COMMERCE & INDUSTRY DEPARTMENT OF INDUSTRIAL POLICY & PROMOTION BULLETIN BOARD FOLLOW UP COMPUTATION OF ROYALTY QUERY : DEAR SIR, ONE OF OUR CORPORATE CLIENT WANTS TO REMIT ROYALTY (NO TECHNICAL KNOWHOW PAID AND ROYALTY RATE IS 5%, HENCE COVERED UNDER AUTOMATIC ROUTE) TO ITS PARENT COMPANY ABROAD. FOR CALCULATION OF ROYALTY, AMONG OTHER DEDUCTIONS, LANDED COST OF IMPORTED COMPONENTS, STANDARD BOUGHT OUT COMPONENTS USED IN THE MANUFACTURE OF THE FINAL PRODUCT HAVE TO BE REDUCED F ROM THE SALE PRICE, ON WHICH ROYALTY IS PAYABLE. THE QUERY IS: OUR CLIENT IS A MANUFACTURING COMPANY, IN WHICH IT IS USING IMPORTED RAW MATERIALS, WHICH ARE MIXED AND USED TO MANUFACTURE THE FINAL PRODUCT. SHOULD THIS RAW MATERIALS ALSO BE TREATED AT PAR W ITH THE IMPORTED COMPONENTS/ BOUGHT - OUT COMPONENTS? AND BE DEDUCTED FROM SALE PRICE TO CALCULATE ROYALTY. WOULD HIGHLY APPRECIATE YOUR GUIDANCE ON THE SAME. ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 17 REPLY : DEAR SIR, IN OUR OPINION, NO. REGARDS BB SHARMA. QUERY : THANKS FOR THE REPLY. JUST TO CONF IRM YOUR VIEW ON COMPUTATION, DOES IT MEAN THAT ONLY BOUGHT OUT COMPONENTS ON WHICH NO FURTHER PROCESSING IS REQUIRED IN THE COMPANY AND ARE DIRECTLY FITTED INTO THE FINAL PRODUCTS ARE TO BE SUBTRACTED FROM THE SELLING PRICE? YOUR GUIDANCE IN THIS REGARD W OULD BE HIGHLY APPRECIATED. REPLY : DEAR SIR: YOUR UNDERSTANDING SEEMS TO BE CORRECT REGARDS B B SHARMA 23. FROM THE AFORESAID, IT IS CLEAR THAT WHAT IS LIABLE TO BE CONSIDERED AS STANDARD BOUGHT - OUT COMPONENTS ARE SUCH MATERIAL ON WHICH NO FURTHER PROCES SING IS REQUIRED AND ARE DIRECTLY FITTED INTO THE FINAL PRODUCT; AND, COST OF SUCH MATERIAL ONLY NEEDS TO BE DEDUCTED FROM THE SALE PRICE TO COMPUTE THE ROYALTY PAYABLE. APPLYING THE SAID CLARIFICATION TO THE PRESENT SITUATION, CONSIDERING THE MANUFACTURI NG PROCESS EXPLAINED, IT CANNOT BE CONSTRUED THAT THE SO - CALLED CONSTITUENT MATERIAL ARE MERELY FITTED INTO THE FINAL PRODUCT; ON THE CONTRARY, IT IS A CASE WHERE SUCH MATERIAL ALSO UNDERGOES A CHEMICAL REACTION IN THE PROCESS OF PRODUCING THE FINAL PRODUC T AND THE SAME ARE IRRETRIEVABLE ONCE THE FINISHED PRODUCT IS MANUFACTURED. FOR THE SAID REASON ALSO, IN OUR CONSIDERED OPINION, THE SO - CALLED CONSTITUENT MATERIALS CLASSIFIED BY THE TPO CANNOT BE EQUATED TO STANDARD BOUGHT - OUT COMPONENTS SO AS TO REDUC E THEIR COST FROM THE SALES VALUE TO COMPUTE THE ROYALTY PAYABLE. FOR ALL THE ABOVE REASONS, WE THEREFORE FIND NO JUSTIFICATION ON THE PART OF THE TPO IN REJECTING THE METHODOLOGY ADOPTED BY THE ASSESSEE TO CALCULATE NET SALES FOR THE PURPOSES OF COMPUTING THE ROYALTY PAYABLE. 24. THE SECOND CONTROVERSY IS WITH RESPECT TO THE ACTION OF THE TPO IN 24. THE SECOND CONTROVERSY IS WITH RESPECT TO THE ACTION OF THE TPO IN CONSIDERING 5% RATE OF ROYALTY PAYMENT ON EXPORT SALES AS ARMS LENGTH PRICE AS AGAINST 8% PAID BY THE ASSESSEE. IN DOING SO, THE TPO HAS APPLIED THE CUP METHOD. AS PER THE TPO, A GROUP COMPANY IN CHINA I.E. TANPC WAS PAYING ROYALTY @ 5% TO THE AE, WHEREAS ASSESSEE WAS PAYING ROYALTY @ 8% TO AE ON EXPORT SALES. ACCORDING TO THE TPO, THE RATE OF ROYALTY BEING CHARGED BY THE AE TO ANOTHER GROUP ENTITY ENGAGED IN MA NUFACTURE OF SIMILAR PRODUCTS, IS A GOOD COMPARABLE FOR THE PURPOSE OF BENCHMARKING ASSESSEES INTERNATIONAL TRANSACTION OF ROYALTY PAYMENT. IN THIS CONTEXT, CLAUSE (A) OF SUB - RULE (1) OF RULE 10B OF THE RULES PRESCRIBES THE MANNER IN WHICH THE ARMS LENG TH PRICE IN RELATION TO AN INTERNATIONAL TRANSACTION IS TO BE DETERMINED UNDER CUP METHOD, WHICH READS AS UNDER : - (A) COMPARABLE UNCONTROLLED PRICE METHOD, BY WHICH, - ( I ) THE PRICE CHARGED OR PAID FOR PROPERTY TRANSFERRED OR SERVICES PROVIDED IN A COMPA RABLE UNCONTROLLED TRANSACTION, OR A NUMBER OF SUCH TRANSACTIONS, IS IDENTIFIED; ( II ) SUCH PRICE IS ADJUSTED TO ACCOUNT FOR DIFFERENCES, IF ANY, BETWEEN THE INTERNATIONAL TRANSACTION AND THE COMPARABLE UNCONTROLLED TRANSACTIONS OR BETWEEN THE ENTERPRISES ENTERI NG INTO SUCH TRANSACTIONS, WHICH COULD MATERIALLY AFFECT THE PRICE IN THE OPEN MARKET; ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 18 ( III ) THE ADJUSTED PRICE ARRIVED AT UNDER SUB - CLAUSE (II) IS TAKEN TO BE AN ARMS LENGTH PRICE IN RESPECT OF THE PROPERTY TRANSFERRED OR SERVICES PROVIDED IN THE INTERNATIONAL TRANSACTION; 25. THE AFORESAID THREE STEPS WOULD REVEAL THAT THE ACTION OF THE TPO IN THE PRESENT CASE IS CONTRARY TO THE PRESCRIPTION CONTAINED IN SUB - CLAUSE (I) OF CLAUSE (A) OF SUB - RULE (1) OF RULE 10B OF THE RULES. OSTENSIBLY, IN TERMS OF SUB - CLAUS E (I), THE PRICE CHARGED OR PAID IN A COMPARABLE UNCONTROLLED TRANSACTION IS TO BE IDENTIFIED FOR THE PURPOSE OF DETERMINING THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION BEING TESTED. IT IS STARKLY EVIDENT THAT IN THE PRESENT CASE, THE COMPAR ABLE TRANSACTION PICKED - UP BY THE TPO, NAMELY, ROYALTY PAYMENT BY TANPC TO THE AE IS A TRANSACTION BETWEEN TWO RELATED/ASSOCIATED ENTERPRISES AND THEREFORE IT IS A CONTROLLED TRANSACTION AND NOT A UNCONTROLLED TRANSACTION. SUCH A TRANSACTION UNDERTAKEN BETWEEN TWO CONTROLLED ENTITIES, IN OUR VIEW CANNOT BE CONSIDERED AS A COMPARABLE UNCONTROLLED TRANSACTION, AS ENVISAGED IN CLAUSE (A) OF SUB - RULE (1) OF RULE 10B OF THE RULES. HENCE, ON THIS COUNT ITSELF, IN OUR VIEW, THE ADJUSTMENT MADE BY THE TPO BY CONSIDERING 5% ON EXPORT SALES AS AN ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION OF ROYALTY PAYMENT HAS TO FAIL. 26. APART THEREFROM, FACTUALLY SPEAKING, ASSESSEE HAS BROUGHT OUT DIFFERENCES BETWEEN THE TWO AGREEMENTS I.E. AGREEMENT BETWEEN ASSES SEE AND THE AE AND THE AGREEMENT BETWEEN TNAPC AND THE AE ON THE OTHER HAND. THE TWO AGREEMENTS DIFFER IN THEIR PERIOD OF OPERATION AS ALSO THE PRODUCTS COVERED; AND SUCH A FACTUAL MATRIX HAS NOT BEEN REBUTTED BY THE REVENUE BEFORE US. HENCE, ON THIS COU NT TOO, THE TRANSACTION OF ROYALTY PAYMENT BY THE CHINESE COMPANY, M/S TNAPC TO THE AE CANNOT BE CONSIDERED AS A CHINESE COMPANY, M/S TNAPC TO THE AE CANNOT BE CONSIDERED AS A COMPARABLE TRANSACTION FOR THE PURPOSES OF DETERMINING THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION OF ROYALTY PAYMENT ON EXPORT SAL ES, UNDER THE CUP METHOD APPLIED BY THE TPO. 27. AS A RESULT OF THE AFORESAID DISCUSSION, WE HOLD THAT THE TPO ERRED IN (I) RE - WORKING THE STATED VALUE OF THE INTERNATIONAL TRANSACTION OF ROYALTY PAYMENT BASED ON HIS INTERPRETATION OF THE EXPRESSION NET SALES AND, (II) CONSIDERING THE ROYALTY PAYMENT BY TNAPC TO THE AE AS A COMPARABLE TRANSACTION UNDER THE CUP METHOD FOR THE PURPOSES OF DETERMINING THE ARMS LENGTH PRICE OF THE INTERNATIONAL TRANSACTION OF ROYALTY PAYMENT CLAIMED BY THE ASSESSEE. AS A CONSEQUENCE THE ADJUSTMENT/ADDITION OF RS.91,66,061/ - MADE IN RESPECT OF ROYALTY PAYMENT IS DIRECTED TO BE DELETED. 13. SIMILAR VIEW HAS BEEN TAKEN BY THE TRIBUNAL IN ASSESSEES OWN CASE IN ASSESSMENT YEAR 2007 - 08 VIDE CONSOLIDATED ORDER DATED 11.02.201 4. THEREAFTER, THE SAID PROPOSITION HAS BEEN APPLIED BY THE TRIBUNAL IN ASSESSMENT YEARS 2001 - 02 , 2002 - 03 , 2008 - 09 AND 2009 - 10 VIDE ORDER DATED 25.07.2014 . FOLLOWING THE SAME PARITY OF REASONING, WE DIRECT THE ASSESSING ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 19 OFFICER TO DELETE THE ADJUSTMENT O F RS. 64,78,990/ - MADE IN RESPECT OF ROYALTY PAYMENT. 14. THE NEXT ISSUE VIDE GROUND OF APPEAL NO.1.4 IS WITH REGARD TO TRANSFER PRICING ADJUSTMENT FOR EXPORT OF CERTAIN GOODS AT RS. 7,99,500/ - . 15. THE FACTS RELATING TO THE ISSUE ARE THAT THE TPO NOTED TH AT ASSESSEE MADE EXPORT SALE OF A PRODUCT, NAMELY, TX423 TO THE ASSOCIATED ENTERPRISES, THE TPO APPLIED THE INTERNAL CUP METHOD BY ADOPTING THE TRANSACTION OF SALE TO THE THIRD PARTIES IN INDIA AS A COMPARABLE UNCONTROLLED TRANSACTION AND ACCORDINGLY MADE ADJUSTMENT TO THE STATED VALUE OF EXPORT SALES CORRESPONDING TO THE DIFFERENCE BETWEEN THE PRICE CHARGED TO THE THIRD PARTIES IN INDIA AND THAT CHARGED TO THE ASSOCIATED ENTERPRISES. THUS, AN ADJUSTMENT OF RS. 7 , 99 , 50 0/ - HAS BEEN WORKED OUT. 16. WE FIND T HAT SIMILAR ISSUE AROSE BEFORE THE TRIBUNAL IN ASSESSEES OWN CASE IN ASSESSMENT YEAR 2006 - 07 AND VIDE ORDER DATED 11.02.2014 , THE TRIBUNAL HELD AS UNDER: - 31. FACTUALLY SPEAKING, IN THE PRESENT CASE ASSESSEE HAS EXPORTED FINISHED GOODS TO ITS AES AND ON E SUCH EXPORT WAS OF A PRODUCT TRIGONOX 25C75. IN SEPTEMBER, 2005 ASSESSEE EXPORTED 9000 KG. OF TRIGONOX 25C75 AT A PRICE RATE OF RS.239/ - PER KG. TO THE AE, WHEREAS THE SAME PRODUCT WAS ALSO SOLD BY THE ASSESSEE ON THREE OCCASIONS IN JULY, AUGUST AND SE PTEMBER; 2005 TO A PARTY IN INDIA IN QUANTITIES OF 1000, 700 AND 1000 KG. RESPECTIVELY @ RS.365 PER KG. . FOR THE SAID REASON, THE TPO CONSIDERED THE SALE OF THE PRODUCT TO THE INDIAN PARTY AS AN INTERNAL COMPARABLE WHILE APPLYING THE CUP METHOD AND DETERM INED THE ARMS LENGTH PRICE OF THE EXPORT TRANSACTION BY ADOPTING THE RATE/PRICE CHARGED FROM THE DOMESTIC PARTY AS THE ARMS LENGTH PRICE. IN OUR CONSIDERED OPINION, THERE IS NO INFIRMITY ON THE PART OF THE TPO IN INVOKING THE CUP METHOD BECAUSE THE PROD UCT SOLD IS IDENTICAL. MOREOVER, IT IS ALSO NOT THE CASE OF THE ASSESSEE THAT THE SALE TO THE AE, THOUGH A SOLITARY INSTANCE, IS NOT A SALE IN THE ORDINARY COURSE OF ITS BUSINESS. THE FACT THAT SOME OTHER PRODUCT HAS BEEN EXPORTED TO THE AE AT RATE HIGHE R OTHER THAN THE RATE AT WHICH IT HAS ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 20 BEEN SOLD IN THE LOCAL MARKET IS NO REASON TO DEFEAT THE ACTION OF THE TPO IN BENCHMARKING THE IMPUGNED INTERNATIONAL TRANSACTION BY APPLYING THE CUP METHOD. BE THAT AS IT MAY, WE MAY NOW CONSIDER THE ALTERNATIVE PLEA OF THE ASSESSEE SEEKING ADJUSTMENTS IN THE PRICE CHARGED FROM THE DOMESTIC BUYER SO AS TO ACCOUNT FOR THE DIFFERENCES BETWEEN THE INTERNATIONAL TRANSACTION OF EXPORT OF THE PRODUCT TO THE AE AND THE COMPARABLE UNCONTROLLED TRANSACTION. ON THIS POINT, WE ARE NOT PERSUADED BY THE ACTION OF THE TPO IN DISREGARDING THE POINTS RAISED BY THE ASSESSEE AND HOLDING THAT NO ADJUSTMENTS ARE REQUIRED. OSTENSIBLY, THE COMPARISON OF SUCH TRANSACTIONS, WHICH IS ELUCIDATED AT PAGE 253 OF THE PAPER BOOK SHOW THAT THE SAL E TO AE IS ON A CREDIT OF 30 DAYS WHEREAS THE TERMS OF CREDIT TO THE LOCAL PARTY IS OF 60 DAYS; SECONDLY, THE SALE TO THE AE IS ON A SINGULAR OCCASION OF 9000 KG. WHEREAS THE SALES TO THE INDIAN PARTY HAS BEEN MADE ON THREE DIFFERENT OCCASIONS OF 1000, 700 AND 1000 KG. . THIRDLY, THE ASSESSEE POINTED OUT THAT THE PRODUCT WAS NOT EXPORTED TO THE ULTIMATE CUSTOMER BUT THE AE CONTRACTED THIS PRODUCT FROM THE ASSESSEE FOR ONWARD SALE TO THE ULTIMATE INDUSTRIAL CONSUMER. THIS ASPECT OF THE MATTER IS EVIDENT FRO M PAGES 199 200 OF THE PAPER BOOK WHEREIN IS PLACED THE COPY OF EXPORT INVOICES/DELIVERY DETAILS OF THE PRODUCT EXPORTED TO THE AE. THE AE ON ITS PART, SOLD THE GOODS TO THE ULTIMATE CONSUMER AT A PRICE EQUIVALENT TO RS. 288/ - PER KG., AFTER BUYING FROM THE ASSESSEE AT RS.239/ - PER KG. . THE LOCAL SALE, ON THE OTHER HAND, IS CLAIMED TO HAVE BEEN MADE TO A CUSTOMER, WHO HAS UTILIZED IT FOR ITS OWN CONSUMPTION. FOURTHLY, ASSESSEE HAS POINTED OUT THAT THE SALES TO THIRD PARTIES REQUIRE CERTAIN LEVEL OF ADD ITIONAL COSTS, VIZ. SELLING, MARKETING, PAYMENT FOLLOW - UP ETC., WHICH IS NOT SO IN CASE OF EXPORT TO THE AE. FIFTHLY, IT IS POINTED OUT THAT THE EXPORT MADE TO THE AE HAS RESULTED IN AN INDIRECT ECONOMIC BENEFIT BY WAY OF OBTAINING ADVANCE LICENSE FOR DUT Y FREE IMPORTS. A ROUGH CALCULATION IN THIS REGARD HAS BEEN FURNISHED AT THE TIME OF IMPORTS. A ROUGH CALCULATION IN THIS REGARD HAS BEEN FURNISHED AT THE TIME OF HEARING IN TERMS OF WHICH IT IS POINTED OUT THAT SUCH ECONOMIC BENEFIT WAS TO THE TUNE OF RS.10 - 11 PER KG. . THE AFORESAID POINTS BROUGHT OUT BY THE ASSESSEE, IN OUR VIEW , ARE BONAFIDE GROUNDS TO PERMIT ADJUSTMENT TO THE COMPARABLE UNCONTROLLED PRICE BEING CONSIDERED IN ORDER TO BENCHMARK THE TRANSACTION OF EXPORT. NOTABLY, SUCH ADJUSTMENT IS CALLED FOR, HAVING REGARD TO THE PROVISIONS OF SUB - CLAUSE (II) OF CLAUSE (A) OF SUB - RULE (1) OF RULE 10B OF THE RULES AND KEEPING IN MIND THE AFORESAID DIFFERENCES. A PERTINENT POINT HAS ALSO BEEN MADE OUT BY THE ASSESSEE THAT AFTER EXPORT TO THE AE, THE SAME PRODUCT HAS BEEN ULTIMATELY SOLD BY THE AE TO A UNCONTROLLED PARTY AT A PRI CE, WHICH CAN BE TAKEN TO BE THE THEN PREVAILING INTERNATIONAL PRICES. THEREFORE, IT IS SOUGHT TO BE MADE OUT THAT THE MAXIMUM PRICE, WHICH ASSESSEE COULD HAVE REALIZED ON EXPORT OF THE PRODUCT TO A NON - AE WOULD BE THE PREVAILING INTERNATIONAL PRICE, WHIC H WAS THE PRICE FOR WHICH THE AE SOLD THE PRODUCT TO THE ULTIMATE CUSTOMER. IT WAS THEREFORE POINTED OUT THAT CONSIDERED IN THE SAID LIGHT, THE ADJUSTMENT PERMISSIBLE IN ORDER TO BRING THE TRANSACTION TO THE LEVEL OF ARMS LENGTH PRICE CAN IT BEST BE REST RICTED TO THE DIFFERENCE BETWEEN THE PRICE CHARGED BY THE AE FROM THE ULTIMATE CUSTOMER AND THE PRICE CHARGED BY ASSESSEE TO THE AE. 32. CONSIDERING THE AFORESAID SUBMISSIONS PUT - FORTH, IN OUR VIEW, IT WOULD BE IN THE FITNESS OF THINGS THAT A CERTAIN LEVEL OF ADJUSTMENT IS MADE TO THE COMPARABLE UNCONTROLLED PRICE OF RS.365/ - PER KG. CONSIDERED BY THE TPO IN ORDER TO MAKE IT COMPARABLE WITH THE IMPUGNED INTERNATIONAL TRANSACTION. PRESENTLY, THE TPO HAS WORKED OUT THE DIFFERENTIAL AT RS.126/ - PER KG. {I.E R S.365/ - (SALE PRICE TO INDIAN BUYER) MINUS RS.239/ - (EXPORT PRICE TO AE)}. ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 21 CONSIDERING THE DIFFERENCES ON ACCOUNT OF : (I) VOLUME OF SALES; (II) EXPORT TO AE AND THEREOF SALE TO ULTIMATE CUSTOMER AND THE DOMESTIC SALE BEING TO THE DIRECT CUSTOMER; (III) A PORTION OF THE PROFIT BEING RETAINED BY THE AE FOR ITS FUNCTIONS PERFORMED; (IV) THE BENEFIT ON ACCOUNT OF LICENSE TO IMPORT GOODS AT CONCESSIONAL IMPORT DUTY; (V) INCURRENCE OF MARKETING/SELLING COST ON DOMESTIC SALES; (VI) DIFFERENCE IN CREDIT TERMS; ET C., IN OUR CONSIDERED OPINION, IT WOULD MEET THE ENDS OF JUSTICE IF THE PRICE OF RS.365/ - PER KG. IS ADJUSTED TO RS.300/ - PER KG. . THE ADJUSTED PRICE OF RS.300/ - PER KG., IN OUR VIEW, IS LIABLE TO BE TAKEN AS AN ARMS LENGTH PRICE IN RESPECT OF EXPORT OF TRIGONOX 25C75 TO THE AE INSTEAD OF THE STATED PRICE OF RS.239/ - PER KG. . AS A RESULT, THE ADDITION OF RS.11,34,000/ - MADE BY THE TPO ON THIS COUNT SHALL BE SCALED DOWN TO RS.5,49,000/ - . ACCORDINGLY, WE DIRECT THE ASSESSING OFFICER TO RESTRICT THE ADJUS TMENT ON ACCOUNT OF INTERNATIONAL TRANSACTION OF EXPORT TO THE AE TO RS.5,49,000/ - INSTEAD OF RS.11,34,000/ - . THUS, ON THIS ASPECT, ASSESSEE PARTLY SUCCEEDS. 1 7 . THE TRIBUNAL WHILE DECIDING THE SAID ISSUE IN ITA NO.2181/PN/2012 , RELATING TO ASSESSMENT Y EAR 2008 - 09 FURTHER OBSERVED AS UNDER: - 25. IN THE LIGHT OF THE AFORESAID, IT IS EVIDENT THAT THE TRIBUNAL DID NOT INTERFERE WITH THE ACTION OF THE TPO IN BENCHMARKING THE IMPUGNED INTERNATIONAL TRANSACTIONS BY APPLYING THE CUP METHOD. SO HOWEVER, WITH REGARD TO THE ALTERNATIVE PLEA OF THE ASSESSEE SEEKING ADJUSTMENT IN THE PRICE CHARGED FROM THE DOMESTIC BUYERS SO AS TO ACCOUNT FOR DIFFERENCES WITH THE INTERNATIONAL TRANSACTIONS OF EXPORT OF PRODUCTS TO THE ASSOCIATED ENTERPRISES WAS ACCEPTED SO AS TO F ACILITATE THEIR COMPARABILITY. AT THE TIME OF HEARING, LEARNED COUNSEL FOR THE ASSESSEE FURNISHED A WORKING, BASED ON THE ORDER OF THE TRIBUNAL DATED FOR THE ASSESSEE FURNISHED A WORKING, BASED ON THE ORDER OF THE TRIBUNAL DATED 11.02.2014 (SUPRA) WHEREBY AN ADJUSTMENT WAS MADE TO THE PRICE CHARGED TO THE THIRD PARTIES SO AS TO MAKE IT COMPARABLE WITH THE PRICE CHARGED FROM THE ASSOCIATED ENTERPRISES. IN TERMS OF THE SAID WORKING, IT IS SUBMITTED THAT IN THE INSTANT YEAR, THE ADJUSTED PRICE WOULD COMPARE FAVOURABLY WITH THE EXPORT PRICE CHARGED FROM THE ASSOCIATED ENTERPRISES AND TH EREFORE NO FURTHER ADJUSTMENT IS REQUIRED IN EXPORT PRICE TO BRING IT TO AN ARM'S LENGTH PRICE. SINCE, THE AFORESAID ASPECT REQUIRES A FACTUAL APPRECIATION, WE THEREFORE DEEM IT FIT AND PROPER TO REMAND THE ISSUE BACK TO FILE OF THE ASSESSING OFFICER, WHO SHALL CONSIDER THE WORKING OF THE ASSESSEE IN THIS REGARD. THE ASSESSING OFFICER SHALL SATISFY HIMSELF THAT THE WORKING HAS BEEN DONE BY THE ASSESSEE IN CONFORMITY WITH THE ORDER OF THE TRIBUNAL DATED 11.02.2014 (SUPRA) ON THIS ASPECT, WHICH WE HAVE REPR ODUCED IN THE EARLIER PARAS. NEEDLESS TO SAY, THE ASSESSING OFFICER SHALL ALLOW THE ASSESSEE A REASONABLE OPPORTUNITY OF BEING HEARD AND ONLY THEREAFTER HE SHALL PASS AN APPROPRIATE ORDER ON THIS ASPECT IN CONFORMITY WITH THE DIRECTIONS OF THE TRIBUNAL DA TED 11.02.2014 (SUPRA). THUS, ON THIS ASPECT ALSO ASSESSEE SUCCEEDS. 18. THE LEARNED AUTHORIZED REPRESENTATIVE FOR THE ASSESSEE FAIRLY POINTED OUT THAT THE ISSUE RAISED VIDE PRESENT GROUND OF APPEAL WAS IDENTICAL TO THE ISSUE BEFORE THE TRIBUNAL IN EARL IER YEARS AND POINTED THAT THE SAME MAY BE SENT BACK TO THE FILE OF ASSESSING OFFICER. IN VIEW OF THE DIRECTIONS OF THE ITA NO. 743 /PN/20 1 4 AKZO NOBEL INDIA LTD. 22 TRIBUNAL IN THE ORDER DATED 11.02.2014 (SUPRA), WHICH IN TURN, HAS BEEN APPLIED IN ASSESSMENT YEAR 2008 - 09 , WE REMIT THIS ISSUE BACK TO THE FILE OF ASSESSING OFFICER TO COMPLY WITH THE DIRECTIONS OF THE TRIBUNAL AND RE - DETERMINE THE ADDITION, IF ANY, IN THE HANDS OF ASSESSEE. THE ASSESSING OFFICER SHALL ALLOW REASONABLE OPPORTUNITY OF HEARING TO THE ASSESSEE . T HE GROUND OF APPEAL NO.1.4 RAISED BY THE ASSESSEE IS THUS, ALLOWED AS STATED ABOVE. 1 9 . IN THE RESULT, THE APPEAL OF THE ASSESSEE IS ALLOWED. ORDER PRONOUNCED ON THIS 19 TH DAY OF FEBRU ARY , 201 6 . SD/ - SD/ - (PRADIP KUMAR KEDIA) (SUSHMA CHOWLA) / ACCOUNTANT MEMBER / JUDICIAL MEMBER / PUNE ; DATED : 19 TH FEBR UARY , 201 6 . GCVSR / COPY OF THE ORDER IS FORWARDED TO : 1. / THE AP PELLANT ; 2. / THE RESPONDENT; 3. ( ) / THE CIT(A) - IT/TP, PUNE ; 4. THE DIT (TP/IT), PUNE; 5. , , / DR A , ITAT, PUNE; / BY ORDER , // TRUE COPY // / SR. PRIVATE SECRETARY , / ITAT, PUNE