Computation of arm’s length price for royalty

IN THE INCOME TAX APPELLATE TRIBUNAL

DELHI BENCH ‘F’ : NEW DELHI

BEFORE SHRI G.D.AGRAWAL, VICE PRESIDENT AND

SHRI A.D.JAIN, JUDICIAL MEMBER

ITA No.5361/Del/2010

Assessment Year: 2004-05

Assistant Commissioner of

Income Tax,

Circle-15(1),

C.R.Building, I.P. Estate,

New Delhi.

(Appellant)

Vs.

M/s Reebok India Co.,

503/1, 3 & 4,

Village Bijwasan,

New Delhi.

PAN: AAACR3007K.

 (Respondent)

Appellant by: Shri Satpal Singh, Sr.DR.

Respondent by: Shri Ajay Vohra, Advocate.

ORDER

PER G.D.AGRAWAL, VP:

This appeal by the Revenue is directed against the order of learned CIT(A)-XX, New Delhi dated 30th September, 2010 for the assessment year 2004-05.

2. The only ground raised by the Revenue reads as under:-

“That on the facts and circumstances of the case and in law, the ld.CIT(A) has erred in holding that the TPO was not justified in including other income with regard to computation of arm’s length price for royalty.”

3. At the time of hearing before us, it was stated by the learned counsel that though the learned CIT(A) has allowed the relief to the assessee on merits, but, even otherwise, the addition is not called for because as per TPO’s order, the difference between the net operating

profit of the assessee and the arm’s length price determined by the TPO is only 1.21% which squarely falls within the safe harbour zone as provided in proviso to Section 92C(2) of the Income-tax Act, 1961 at the relevant time. He, therefore, submitted that without going into the merits of the learned CIT(A)’s order, though the same is in favour of the assessee, the addition made by the Assessing Officer is not sustainable.

4. Learned DR, on the other hand, stated that in page 11 of the TPO’s order, the TPO has pointed out that the assessee’s case does not fall within the range of +- 5% as provided in proviso to Section 92C(2). He, therefore, submitted that the order of the TPO should be sustained.

5. We have carefully considered the submissions of both the sides and perused the material placed before us. From a perusal of the order of the TPO, we find that during the accounting year relevant to assessment year under consideration, the assessee has undertaken various international transactions as under:-

6. The TPO accepted the assessee’s explanation with regard to the arm’s length price of all other transactions except royalty. This would be evident from the following observations at page 5 of the TPO’s order:-

“Since the arm’s length price of the International Transactions related to the receipt of commission, export of goods to the AE and purchase of goods from the AE hasalready been computed by the assessee, the arm’s length price of the international transactions related to the payment of royalty has only to be determined. For that purpose the net operating margin of the assessee attributable to the payment of royalty are only to be calculated.”

7. The arm’s length price of the royalty is determined at pages 9 & 10 of the TPO’s order. He determined the arm’s length price of royalty under TNMM method, the relevant portion of which at page 9 reads as under:-

“Net operating profit Rs.5,40,98,579

NPM (%) 5.02%

Arm’s length NPM as computed by the assessee 6.23%

Net operating margin at Arm’s Length Rs.6,70,80,532

Difference Rs.1,29,81,953

Accordingly, the Arm’s length price of international transaction related to payment of royalty is computed at Rs.3,12,29,088/- against the declared value of Rs.4,42,11,041/-.”

8. At page 11, the TPO has given the following reasons why the proviso to Section 92C(2) which provides for not making of adjustment if the variation is within the limit of +- 5% is not permissible:-

“The Arm’s Length Price of the international transaction related to payment of royalty has thus been computed at Rs.3,12,29,088/-. The (+) range of the Arm’s Length Price is Rs.3,27,90,542/- (+5%) to 2,96,67,633/- (-5%). Since the value of international transaction is Rs.4,42,11,041/-, which falls outside the (+5%) tolerance band, the assessee is not entitled to the benefit of proviso to sub-section (2) to section 92C of the Income Tax Act.”

9. The proviso to Section 92C as it stood at the relevant time reads as under:-

“Provided that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean.”

10. From the above, it is evident that the assessee has an option to adopt a price which may vary from the arithmetical mean of ALP by an amount not exceeding 5% of such arithmetical mean. In the case of the assessee, the Assessing Officer has determined the ALP of royalty by only one method, i.e., TNMM which was determined at 6.23%. Therefore, arithmetical mean of ALP determined by the TPO is 6.23%. The net profit margin of the assessee was 5.02%. The assessee has an option to adopt a price which may vary from arithmetical mean of ALP up to five per cent. The difference between the net profit of the assessee and NPM of the arm’s length price is certainly less than 5% and, therefore, the assessee has a right to claim that the NPM of the assessee i.e. 5.02% should be adopted as arm’s length price. The TPO had determined the arm’s length price of royalty by TNMM. Thereafter, he worked out the addition which may be required to be made under the head ‘royalty’ and then he compared the royalty paid by the assessee and the ALP of royalty determined by him. However, we find that the proviso refers to the arm’s length price determined by various methods and adopting of the mean of such method and then the assessee had been given an option to adopt a value which should not vary more than 5% from the mean of the ALP determined by the TPO. Therefore, what is to be varied is the percentage of the ALP determined by the TPO as per most appropriate method. In this case, the TPO considered TNMM to be the most appropriate method and accordingly determined the arm’s length price at 6.23%. Therefore, the assessee has a right to adopt the ALP within the variation of 5% from 6.23%. The NPM declared by the assessee is 5.02% and, therefore, as per proviso to Section 92C(2), the assessee is fully justified to claim that since the difference between the NPM declared by him and the ALP determined by the TPO is less than 5%, no addition is called for. We, therefore, agree with the assessee’s contention and uphold the order of learned CIT(A) deleting the addition of `1,29,81,953/- made by the TPO, of course, for the reasons different than the reasons given by learned CIT(A) for deleting the addition.

11. In the result, the appeal of the Revenue is dismissed.

Decision pronounced in the open Court on 17th May, 2013.

Sd/- Sd/-

(A.D.JAIN) (G.D.AGRAWAL)

JUDICIAL MEMBER VICE PRESIDENT

Dated: 17.05.2013

VK.

Copy forwarded to: -

1. Appellant: Assistant Commissioner of Income Tax, Circle-15(1), C.R.Building, I.P. Estate, New Delhi.

2. Respondent: M/s Reebok India Co., 503/1, 3 & 4, Village Bijwasan, New Delhi.

3. CIT

4. CIT (A)

5. DR, ITAT

Assistant Registrar