On March 29, 2012 Hon’ble High
Court of Delhi pronounced a land mark judgment in case of ELK Appliances Ltd.,
wherein it observed that tax officer is not authorised to disallow the payment
made for brand fee or royalty while determining an arm’s length price of the
same.
Facts of the Case
This case relates to financial
year 2001-02 and 2002-03. EKL Appliances Ltd. (‘taxpayer’), Group Company of
Electrolux group, was engaged in the business of manufacturing of
refrigerators, washing machines, compressor and spares thereof and also trading
all these items and microwaive ovens, dish washers, cooking ranges, air
conditioners and spares thereof. In respect of the assessment
years 2002-03 and 2003-04, it filed returns of income declaring losses
amounting to Rs. 148,23,80,117/- and Rs.
1,14,59,660/- respectively. The Assessing Officer noticed that there were
international transactions entered into by the taxpayer during the relevant
previous years and accordingly invoked the provisions of Section 92CA(3) of the
Act and referred the question of determination of the Arms Length Price (“ALP)
to the Transfer Pricing Officer (“TPO”).
The TPO noticed that the taxpayer
has been incurring huge losses year after year except for the financial year
1999-2000 and considering the perpetual losses, “the payment of royalty to the
Associate Enterprise did not appear justified, as the technical knowhow/ brand
fee agreements with A.E. had not benefited the taxpayer company in achieving
profits from its operations”. The TPO further noted that the taxpayer itself
stopped the payment from 01.10.1998 till 01.01.2002 and thus “the justification
for payment of brand fee during the year under reference becomes questionable”.
He conceded that there was an
increase in the turnover but observed that it has not resulted in any profit to
the taxpayer. According to him, despite the payment of the brand fee for
several years, the taxpayer has not been able to make a turnaround. He further
held that the fact that the A.E. had charged similar brand fee from another
company in New Zealand did not prove that the price paid by the taxpayer for
obtaining the use of the brand name and the technical knowhow represented the
ALP. He was of the view that the taxpayer had to demonstrate the actual benefit
derived by it by using the brand name which it had failed to do. The continuous
losses according to the TPO showed that the taxpayer did not benefit in any way
from the brand fee payment. For these reasons, the TPO held that the brand fee
payment made by the taxpayer to the A.E. was unjustified and the ALP of the
transactions should be taken as nil.
Observations
of Hon’ble High Court of Delhi
The Hon’ble High Court of Delhi
ruled in favour of the taxpayer and observed,
- It is not necessary for the taxpayer to show that any legitimate expenditure incurred by him was also incurred out of necessity.
- 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.
- The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allow-ability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the taxpayer has suffered continuous losses.
- It is also not necessary for the taxpayer to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred “wholly and exclusively” for the purpose of business and nothing more.
- The TPO is expected to examine the international transaction as he actually finds the same and then make suitable adjustment.
This judgement should bring a
good relief for other taxpayers also, as in number of cases the Revenue has disallowed payment of royalty or brand fee because of low profitability or no
profitability. As the judgment suggests that profitability should not be the
criteria to allow or disallow the payment, it is recommended that the taxpayer
should try to benchmark transactions like payment of royalty/ brand fee or say
management charges using comparable uncontrolled price method or cost plus
method. Transactional Net Margin Method, considering payer of expenses as the
tested party should be avoided.
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CA Gaurav Garg
JGarg Economic Advisors Pvt. Ltd.
(M) +91 98999 94934
(E) gaurav@jgarg.com
www.jgarg.com
