TPO Lacks Jurisdiction To Question Commercial Expediency Or Genuineness Of Need: Delhi High Court

The Delhi High Court has held that the statutory authority conferred upon the Transfer Pricing Officer (TPO) can only extend to an examination of the appropriateness of the method adopted for the purposes of determining arm's length pricing (ALP) or evaluating the enlistment of comparables. However, the TPO would neither be justified nor could it be countenanced to have the jurisdiction to question commercial expediency or genuineness of need.

The bench of Justice Yashwant Varma and Justice Purushaindra Kumar Kaurav, while upholding the Tribunal's order, held that the assumption of the respondent-assessee being a contract manufacturer as well as the premise of payment of royalty “to itself” could not be sustained.

The respondent-assessee was incorporated in October 2005 and is a wholly owned subsidiary of Samsung Electronics Co. Ltd., Korea. The assessee is in the business of manufacturing and selling mobile phones under the Samsung brand. Samsung Telecommunications India (STI) manufactures and sells mobile handsets in India as well as overseas. The design, know-how, and other critical components are provided to it by Samsung Korea in terms of a Technology License Agreement dated February 26, 2006, which obliges STI to pay for technical assistance as well as royalties.

During the AY, STI paid a technical assistance fee and royalty. A sum of INR 1,99,57,161 was paid by it as royalty on sales made to other Associated Enterprises (AEs). A Return of Income was filed, which was selected for scrutiny pursuant to which notices under Section 143(2) as well as Section 142(1) of the Income Tax Act, 1961, came to be issued.

A show cause notice was issued to STI by the transfer pricing officer in the course of examining a reference made to it pertaining to the payment of royalty to Samsung Korea. STI submitted that the royalty payment to Samsung Korea was in consideration of the receipt of technical know-how and expertise. STI operates as a licensed manufacturing company as opposed to a contract manufacturer, and the export sales made by it to AEs' are driven by open market conditions, which was a position that was obtained even in respect of sales made to unrelated parties.

The TPO determined the arm's length price of royalty paid by STI to its AEs' for exports made as nil. Consequently, the TPO recommended adding to the total income of the assessee. A draft assessment order came to be framed, which was assailed by way of objections preferred before the Dispute Resolution Panel. The DRP upheld the additions that were proposed, and the final assessment order was framed.

During the pendency of the proceedings, identical questions arose for FY 2007–08. The appeal reached the Tribunal, which rendered a final decision thereon on June 21, 2013. While dealing with the issue of royalty and the additions that were made in that respect pursuant to the recommendations of the TPO as affirmed by the DRP, the Tribunal held that the TPO has not demonstrated any facts or circumstances substantiating that the transfer price of goods includes a license charge or royalty, and therefore, any additional payment for intangibles needs to be disallowed. If that was the case, then the TPO should have demonstrated the impact of the same on the transaction value of raw materials purchased from group companies. On the contrary, TPO has accepted the transaction value of the purchase of raw materials and consumables to be at arm's length using the TNMM.

The department contended that STI was operating in the capacity of a contract manufacturer on behalf of Samsung Korea, inasmuch as STI purchased raw material to manufacture goods in India and exported the same to its AEs'. The royalty, as a concept, envisages payments made to a third party for its intangible expertise, i.e., the technical know-how required for the manufacture of goods. The transaction between STI and its AEs could not be considered to be at arms' length, because of which the TPO was justified in determining the arms' length value of royalty payments at 'Nil'.

The assessee contended that the Tribunal was clearly justified in setting aside the draft assessment order, bearing in mind the undisputed position that STI had exported mobile phones not only to its group companies but also to third parties. A majority of those export sales had been made to third parties, and a minuscule percentage of the said exports pertained to group entities.

The assessee argued that the AO as well as the DRP had committed a manifest illegality in holding that while affecting sales to group companies, the assessee had acted merely as a contract manufacturer. The view is rendered wholly untenable and proceeds in ignorance of the fact that STI operated as a full-fledged licensed manufacturer in its own right and could not be viewed as a contract manufacturer.

The court held that the broad generalization that appears to have weighed upon the TPO as well as the DRP is clearly erroneous and fails to take into consideration the indubitable fact that the ascertainment of an ALP could well be in relation to transactions entered into between related parties.

The court, while dismissing the appeal, held that sales made by STI to its group companies were driven by open market conditions and were on par with sales made to unrelated parties. The Tribunal was thus justified in observing that the adoption of the aforenoted tests was demonstrative of the TPO seeking to question the economic substance of the underlying contract. Thus, the TPO as well as the DRP clearly appear to have misconstrued the agreement in terms of which know-how and expertise were licensed to STI.

Counsel For Appellant: Sanjay Kumar

Counsel For Respondent: Himanshu Sinha

Case Title: PCIT Versus Samsung India Electronics Pvt. Ltd.

Citation: 2024 LiveLaw (Del) 776

Case No.: ITA 40/2018

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