Delhi ITAT: Royalty rates approved by RBI, accepted as CUP

In ruling dated December 16, 2011, Income-tax Appellate Tribunal of Delhi (‘Delhi ITAT’) ruled in favor of the taxpayer, Sona Okegawa Precision Forgings Ltd., wherein arm’s length price of the royalty payment to associated enterprise was computed as Nil by the transfer pricing officer.

Sona Okegawa Precision Forgings Ltd. (‘the taxpayer’) is a joint venture between Sona Holding and Mitsubishi Materials Corporation, Japan (‘the associated enterprise’). The taxpayer was formed in 1995 and began commercial production in November 1998. The taxpayer is engaged in the manufacturing of precision forged (net shaped) bevel gears, differential case assemblies and synchroniser rings for automotive and other applications.

During the financial year 2005-06, the taxpayer had several transactions including payment of royalty with its associated enterprise. In order to validate the arm’s length nature of payment of royalty, the taxpayer relied upon the technical collaboration agreement approved by the Government of India for payment of royalty @ 1% and 3% of net sale price of the manufactured goods sold or used by the taxpayer as Comparable Uncontrolled Price (‘CUP’). As a corroborative method, the taxpayer also relied upon the transactional net margin method.

The case was selected for the transfer pricing audit, wherein the transfer pricing officer rejected the CUP analysis carried out by the taxpayer and observed that:

• The taxpayer is a contract manufacturer and as per guidelines issued by OECD, there is no justification for payment of royalty in such a case.
• Secondly, the taxpayer has itself created provision for technical know-how separately as seen from the schedules of the audit report.

 The taxpayer, filed an appeal before Dispute Resolution Panel and the same was turned down.

The taxpayer, appealed with Delhi ITAT and Hon’ble Delhi ITAT observed;

• On issue relating to royalty - The taxpayer has placed on record a copy of the letter dated 30.04.1993 written by the Reserve Bank of India, Exchange Control Department, to the taxpayer, in which payment of royalty @ 3% on domestic sales was allowed to be paid for a period of five years. There are similar other correspondences which have been placed on record. The taxpayer has also placed on record a press note issued by the Government of India, Ministry of Commerce and Industries, Department of Industrial Policy & Promotion, issued in 2003, under which royalty payment @ 8% on export sales and 5% on domestic sales have been referred to be reasonable for the purpose of processing approval of payments. On the other hand, the officer failed to bring any material on record that payment of royalty @ 3% was not at arm’s length. Therefore, the payment stands justified under the CUP method.
•  On issue relating to contract manufacturer – Bulk of sales are to uncontrolled parties. Thus, the taxpayer is not a captive manufacturer supplying all manufactured goods to its associated enterprise. In fact, the technology has been used for manufacturing and supplying goods to independent parties.

My Comment’s

I am bit skeptical about usage of rates allowed by the Reserve Bank of India as CUP for the purpose of transfer pricing analysis under light of this ruling. I am of the feel that this ruling is more because of the fact that the transfer pricing officer not did his homework well and not submitted any CUP data to say transaction between the taxpayer and its associated enterprises was not at arm’s length. Further, Hon’ble High Court of Punjab and Haryana in case of M/s Coca-Cola India Inc. vs. ACIT (C.W.P. No.16681 of 2005)

“The contention that according to the permission granted by the Reserve Bank of India under the FERA, the assessee cannot charge more than particular price, can also not control the provisions of the Act, which provides for taxing the income as per the said provision or computation of income, having regard to arm’s length price in any international transaction, as defined.”

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Chennai ITAT: Uncontrolled price on date of sales contract should be considered as CUP

In case of Liberty Agri Products (P) Ltd (IT APPEAL NO. 1610 (MDS.) OF 2010), the Income-tax Appellate Tribunal of Chennai (‘Chennai ITAT’) has observed that uncontrolled price on the date of sales contract should be considered as comparable uncontrolled price (‘CUP’) instead of uncontrolled price on the date of shipment received on the port.

Liberty Agri Products (P) Ltd. (‘Taxpayer’) is a part of M/s Kuok Group. During FY 2005-06, the taxpayer entered into transactions with its group company in Singapore, wherein the taxpayer purchased edible oil worth USD 23,530,749.06 and applied CUP as the most appropriate method. For the purpose of CUP, the taxpayer relied upon internal CUP (i.e. sales made by the associated enterprise in comparable transactions to third parties in India) and also on notification issued by the Custom Authorities in respect of tariff value on import of edible oils on the date of signing of sales contract. As corroborative evidence the taxpayer also documented the rates of oil published by Solvent Extractors Association of India in relation to degummed soya bean oil could also be well relied on.

During the transfer pricing scrutiny, the transfer pricing officer rejected the CUP data of the taxpayer and instead took Customs average rage at Kandla Port. As there was difference of more than 5% per metric ton, the transfer pricing officer suggested an addition of Rs. 26. 13 million.  

The taxpayer appealed before the Chennai ITAT, after an unsuccessful attempt before lower authorities.

Chennai ITAT agreed to the contentions of the taxpayer that instead of comparing the price with the Customs tariff rate on the date of entry into the port, the transfer pricing officer should have compared the price declared by the taxpayer with the Customs tariff rate at Kandla Port as it is stood on the day of contract of sale entered into between the taxpayer and its associated enterprise. Further, Chennai ITAT also observed that in these types of bulk purchases and sales, it is always better to compare the price of individual consignments rather than on a compromise of average price. 

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Gaurav Garg

JGarg Economic Advisors

New Delhi, India

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