Royalty Payment For Use Of Technology Is Inextricably Linked With Manufacturing Activity: Bombay High Court

The Bombay High Court has held that the transaction of payment of royalty for the use of technology is inextricably linked with manufacturing activity and should be aggregated with other international transactions in the manufacturing segment for the purposes of benchmarking it.

The bench of Justice K.R. Shriram and Justice Firdosh P. Pooniwalla has observed that the Tribunal was totally incorrect in saying that accepting the aggregation of royalty payments with other international transactions under the manufacturing segment for the Assessment Year 2006-2007 was in the context of an earlier agreement under which the royalty was paid.

The assessee/appellant is engaged in the business of manufacture and sale of Internal Combustion Engines, Spares, Components (including Bought-Outs), and Generating sets; service of Engines and gensets; generating sets; and allied equipment, etc. The assessee has a 100% export-oriented unit at Pirangut that is engaged in the manufacture and export of internal combustion engines and their accessories, as well as generator sets and accessories.

The returns filed by the assessee were selected for scrutiny assessment by issuing statutory notices under sections 143(2) and 142(1). The assessee had entered into various international transactions with its Associated Enterprise(s) in the course of its business.

Assessee had paid royalty to its Associated Enterprise, i.e., Cummins Inc., for providing technical know-how and technical knowledge for the manufacturing of engines to be sold to customers.

The TPO issued a notice in which the aggregation of royalty transactions with other transactions at the entity level was doubted and directed the assessee to show cause why the royalty rate used for domestic sales should not be used for benchmarking the royalty on export transactions as well.

The assessee replied that for the purposes of benchmarking, it had aggregated the payment of royalty along with other international transactions involving manufacturing activity. As the use of technology and consequential payment of royalties are closely linked to the manufacturing activity of the assessee, they were aggregated for the purposes of benchmarking. The manufacturing segment was benchmarked using the Transactional Net Margin Method and selecting external comparable companies. Based on the benchmarking analysis, the assessee contended that the international transactions undertaken by it, including the payment of royalty, are at arm's length.

The TPO passed an order accepting Assessee’s contention for aggregation of transactions and application of the TNMM to test the ALP of most of Assessee’s international transactions. Insofar as the payment of royalty made by Assessee to its Associated Enterprise is concerned, the TPO, after accepting the fact that Assessee had indeed received technology from its Associated Enterprise, rejected the contention of Assessee that it should aggregate the royalty paid with the other international transactions in the manufacturing segment for benchmarking. The TPO made an upward adjustment to the value of international transactions pertaining to the payment of royalty on export sales.

The assessee filed objections before the DRP. The DRP issued its directions under Section 144(5) rejecting the assessee’s contentions and holding that the transactions of royalty payment for export sales are to be segregated and benchmarked on a transaction-by-transaction basis, as was done by the TPO. Following the directions of DRP, the respondent passed the final assessment order, making transfer pricing adjustments.

In the final assessment order, the assessee preferred an appeal before the Income Tax Appellate Tribunal (ITAT). ITAT upheld the action of the authorities below in making that transfer price adjustment to the international transaction of payment of royalty.

The court ruled that the Tribunal misread the law laid down in the Delhi High C

Case Title: Cummins India Limited Versus ACIT

Case No.: Income Tax Appeal No.126 Of 2023

Date: 28/07/2023

Counsel For Petitioner: J. D. Mistri

Counsel For Respondent: Suresh Kumar

Click Here To Read The Order