Commissioner of Income Tax v. Keihinpanalfa Ltd.

1. These appeals have been preferred by the Revenue under Section 260A of the Income Tax Act, 1961 (hereafter the 'Act') impugning a ITA II &12of2015 PageI of10 2015:DHC:11433-DB common order passed by the Tribunal in ITA 3287/Del/2011 and 5546/Del/2012.The said appeals were also preferred by the Revenue against the orders passed bythe Commissioner ofIncome Tax(Appeals)[hereafter 'CIT(A)']on 29/03/2011 and 27/08/2012 allowing the appeals preferred by the Assessee against the assessment orders passed by the Assessing Officer (hereafter 'AO')in respect ofthe Assessment Years 2004-05 and 2005-06 respectively.

2. The controversy involved in the present case relates to the Transfer Pricing Adjustment(hereafter'TP Adjustment')made by the AO in respect ofinternational transactions relating to the purchases made and the royalty paid bythe Assesseeto Keihin Corporation,Japan(hereafter'KC').

3. The relevantfacts relating to the assessment year2004-05 are narrated as under:- 3.[1] The Assessee is engaged in the manufacture and sale of airconditionersforcars manufactured byHonda Siel CarsIndiaLtd.Duringthe relevant previous year,the Assessee entered into 'international transactions' for purchase ofparts and components;paymentofguidance fee;paymentof royalty; and payment offees for technical know-how. As the international lTAII&12of2015 />«g.2o//0 transactions were more than Rs.[5] crores in value, a reference was made to Transfer Pricing Officer (hereafter 'TPO') for determining of the Arm's Length Price(hereafter'ALP')under the provisions ofSection 92CA ofthe Act. 3.[2] The Assessee submitted a Transfer Pricing Report calculating the ALP by using Transactional Net Margin Method (hereafter'TNMM')and using the ratio of Operating Profit to Capital Employed as the Profit Level Indicator (hereafter 'PLI'). The TPO accepted TNMM as the appropriate method but rejected the PLI adopted by the Assessee. He used Operating Profits to Total Cost as the appropriate PLI and computed the PLI of comparables at[8].29% as againstthe Assessee'sPLI of[6].22%. 3.[3] The total operating income/revenue of the Assessee for the relevant period was Rs.72,24,22,000/-. Applying the margin of 8.29% - as determined by the TPO on the basis of selected comparables - the TPO concluded that the total operating expenses ought to have been Rs.66,71,17,924/-. Since the actual operating expenses incurred by the Assessee during the period were Rs.68,00,88,000/-,the TPO held that a TP Adjustment of Rs.1,29,70,076/- ought to be made in respect of expenses lTAII&I2of20I[5] Page3of10 ) I attributable to the international transactions. Insofar as the payment of royalty ofRs.1,24,41,118/- is concerned,the TPO had held that no royalty would be payable if the transactions were on Arm's Length basis as according to the TPO, the Assessee was functioning as a contract manufacturer. The TPO observed that all the sales were being made by the petitioner to Honda Siel Cars India Ltd. and 99.99% ofthe said company were held by Honda Motors Co.Ltd.(Japan),which also held 41.33% ofKC (the AE in the present case). KC in turn held 74% shares in the Assessee. The TPO reasoned that since the products being manufactured by the Assessee were specifically designed for Honda Cars Produced by Honda Siel CarsIndia Ltd.and the technical designs and intellectual property rights were held by their parent/group companies, the Assessee was in effect manufacturing for its related enterprise and, therefore, payment of any royalty on sales would be unreasonable. The TPO made observations to the effect that the payment ofroyalty had,in fact, inflated the operating costs and was"villain ofthe piece". 3.[4] The Assessing Officer passed an Assessment Order dated 26^'' December,2006 making an addition ofRs.1,29,70,076/- on account of TP Adjustment made by the TPO.The Assessee had reflected Rs.1,24,41,000/- ITA 11&12of2015 Page4of10 ) as expenses on Royalty. The TPO computed the ALP for royalty as Nil, which was subsumed in the TP Adjustment ofRs.1,29,70,076/-.In addition, the AO disallowed 25% ofthe expenses on account ofroyalty amounting to Rs.22,53,000/- as being capital in nature.

4. With respect to the Assessment Year 2005-06,the TPO did not draw any adverse inference with respect to the international transactions except the transaction relating to payment ofroyalty. The TPO followed a similar reasoning as adopted in respect ofAssessment Year 2004-05 and passed an order dated 24^*^ October,2008 directing the AO to make an addition ofa sum ofRs.1,97,40,726/- being the amount ofroyalty,for the Financial Year 2004-05.The AO,following the directions ofthe TPO,made an addition of the aforesaid sum and passed an assessment order dated 29^^ December,

2008.

5. The Assessee preferred appeals before the CIT(A) against the assessment orders dated 26"" December,2006 in respect ofthe Assessment Year2004-05 and assessmentorder dated 29^*"December,2008in respectof the Assessment Year 2005-06.

6. The CIT(A), by an order dated 29^*" March, 2011 allowed the ITA II & 120/2015 Assessee's appeal against the assessment order dated 26"" December,2006. Before the CIT(A)the Assessee contended that the computation ofthe TP Adjustment was flawed, inasmuch as, the TPO had also attributed TP Adjustments relating to uncontrolled third party transactions to the international transactions. The international transactions in issue constituted only 23.38% ofthe total expenses and,therefore,the adjustment on account of operating expenses attributable to international transaction would necessarily be in the same proportion. According to the Assessee,the same would amount to Rs.30,33,593/-. The expenses attributable to the international transaction (i.e. 23.38% of the total expenses) amounted to Rs.15,90,66,935/- and after the TP Adjustment, the expenses on Arm's Length basis were computed at Rs.15,60,33,342/- (i.e. 15,90,66,935/- - 30,33,593/-). The Assessee furthercontended that5%ofthe ALP computed as above would amount to Rs.78,01,667/-. The Assessee urged that the TP Adjustment fell within the aforesaid range and, therefore, by virtue of second proviso to Section93CA,no TP Adjustments were liable to be made. This contention was accepted by the CIT(A)and the TP Adjustments made by the AO were deleted.

7. The CIT(A)also held that the TPO was in error in holding that no lTAlI&I2of20I[5] royalty was payable. The CIT(A)held that the functions performed by the Assessee included procurement and inventory management,production and manufacturing planning, co-ordination of production and sales, import of goods, maintenance of production facilities and quality control functions; therefore,the Assessee could not be considered as a contract manufacturer. The CIT(A) also held thatthe TPO exceeded itsjurisdiction by rejecting the agreements entered into between the Assessee and the KC and not computing the ALP in accordance with the Act.

8. The CIT(A)also allowed the appeal preferred by the Assessee against an order dated 29^'' December, 2008 passed by the AO in respect of AssessmentYear2005-06forthe same reasons as indicated in respectofthe appeal relating to Assessment Year2004-05.

9. The Revenue appealed againstthe decisions ofthe CIT(A)before the Tribunal. Before the Tribunal, the Assessee conceded that it had no objection to the decision of the TPO regarding the adoption of PLI of Operating Profit to Total Cost. However, the Assessee urged that the adjustments computed in respect ofthe entire expenses could not be loaded on the international transactions. The Tribunal upheld the orders passed by ITA II&12of2015 Page 7of10 I the CIT(A) and rejected the appeals by a common order dated 6'^ May,

2014.

10. The learned counsel appearing for the Revenue contended that the Tribunal has grossly erred in apportioning the adjustment on account of expenses over the uncontrolled transactions and international transactions. He urged that in respect of the Assessment Year 2004-05, the entire adjustment on account of the difference in operating expenses of Rs.1,29,70,076/- as determined bythe TPO oughtto have been adjusted only against the international transaction, which admittedly constituted only 23.38% ofthe operating income/revenue. He next referred to the technical collaboration agreement dated 12^^ September, 1997 entered into between KC and the Assessee and contended that the royalty paid by the Assessee wasin excess ofthe amounts as computed underthe said agreement.

11. Insofar asthe contention thatthe amounts paid were notin accordance with the agreement between the Assessee and the KC is concerned, we find that no such contention had been urged by the Revenue either before the CIT(A)or before the Tribunal. Therefore,in our view,no such plea can be permitted to be taken forthe firsttime in these proceedings. ITAII&I2of2015 ■ Page8of10 12, The contention that the adjustment on account of expenses as determined by the TPO must be attributed entirely to the international transaction is bereft of any merits. During the Financial Year 2003-04 relating to the Assessment Year 2004-05, the Assessee had reported an operating income of Rs.72,24,22,000/-. The total expenses for the said period amounted to Rs.68,00,88,000/-. Admittedly, the international transactions in question amounted to Rs.15,90,66,935/- which were only 23.38% in value of the total expenses. The TPO had determined the PLI (Operating Profit over Total Cost) of comparable cases at 8.29% against 6.22% as declared by the Assessee. Applying the PLI ofcomparable cases, the adjusted total expenses were computed at Rs.66,71,17,924/-, thus, indicating an adjustmentofRs.1,29,70,076/-. Asis apparentfi-om the above, the said adjustment related to entire expenses and notjust the international transactions alone. Since the international transactions only constituted 23.38%, a TP Adjustment proportionate to that extent could be made in respect of such international transactions. Thus, only an adjustment of Rs.30,33,593/- could be attributed to the international transactions in question. The same was accepted by the CIT(A)as well as the Tribunal. We do notfind any infirmity with their decision. ITAn&I2of20l[5] Page9of10

13. We also find no infirmity with the view of CIT(A)and the Tribunal thatthe Assessee had acted like any other Original EquipmentManufacturer (OEM)and could notbe treated as ajob worker or a contractor.

14. We find no substantial question of law that arises for our consideration in these appeals. Accordingly,the appeals are dismissed. No order as to costs.