Section 92C
A. Where the assessee entered into a royalty payment agreement with its AE and made the payment of the same after taking approval from the RBI, then the payment of the said royalty made by the assessee in such circumstances is to be allowed and it cannot be said that the RBI’s approval cannot be considered as an arm’s length benchmark.
B. When taxes on royalty paid is to be borne by the assessee, on account of a commercial arrangement, the said taxes borne by the assessee should not be questioned while calculating arm’s length price.
Facts I:
The assessee, ‘J&J India’, had entered into international transactions with its AE, ‘J&J US’. It had paid the brand name royalty and the trademark royalty net of taxes at the rate of 1% of net sales to ‘J&J US’ for the use of brands and trademarks as per the terms of the brand usage agreement and also paid technical know-how royalty at the rate of 2% to ‘J&J US’ for the technical/marketing know-how provided to the assessee as per the terms of the know-how agreement entered into between the assessee and ‘J&J US’.
The assessee adopted the Transactional Net Margin Method (TNMM) for determining the arm’s length price (ALP) of its international transactions.
TPO made the following disallowances
1. A s per the agreement entered into by the assessee with ‘J&J US’, the assessee was not required to bear the tax liability of ‘J&J US’ arising out of payment of trademark/brand name royalty. Thus, the taxes borne by the assessee on the trademark/brand name royalty paid to ‘J&J US’ was disallowed by the TPO.
2. T he TPO was of the opinion that royalty on sales of traded finished goods was already part of the brand royalty and no royalty was required to be paid for the traded products and hence disallowed the same.
3. T he TPO restricted the technical know-how royalty paid at the rate of 2% to 1%.
4. T he TPO disallowed corresponding taxes and Research & Development Cess on technical knowhow royalty.
On appeal, the CIT(A) confirmed the disallowance of taxes paid by assessee on payment of trademark/ brand name royalty to ‘J&J US’ whereas deleted the other disallowance made by the TPO.
The cross appeals by the assessee and the Revenue were directed against the order of the Ld. CIT(A). Also on second appeal, the assessee submitted that the royalty payments had been approved by RBI.
Held I:
1 T axes paid by assessee on trademark/brand name royalty
The application made by the assessee to RBI for brand usage agreement specifically mentions that the royalty is to be remitted net of taxes. Further, the approval was received from the RBI to remit the royalty on brand usage by the assessee at the rate of 1% net of taxes. Considering the brand usage agreement vis-à-vis the approval granted by RBI, it can be safely inferred that the taxes were liability of the assessee under the terms of agreement. The assessee has entered into a commercial arrangement with ‘J&J US’ and it has been so arranged that the payment of taxes have to be borne by the assessee being a commercial arrangement, the same should not be questioned while calculating arm’s length price. Considering the entire facts in totality in the light of the brand usage agreement and the approval of the RBI, the findings of the CIT(A) is set aside and the AO is directed to delete the addition of the said taxes paid by assessee on trademark/brand name royalty.
2. Royalty payment on sales of traded finished goods
It is already held that the agreements between the assessee and ‘J&J USA’ for payment of royalty have to be considered in the light of the approval of the RBI. There is no substance in the findings of the TPO that there is no need for paying royalty on sales of traded finished goods. There is also no force in the findings of the TPO that this royalty is deemed to be included in the Brand royalty. Therefore, findings of the Ld. CIT(A) were not interfered with.
[The contention of the assessee before CIT(A), on the basis of which CIT(A) had deleted the addition made by TPO of royalty on sales of traded finished goods, was as follows-
Even if the products under consideration are old that does not debar the assessee from paying the royalty now. It was further contended that the assessee continues to get new products from time to time and also gets updates on existing products. The assessee pointed out that the allegation of the TPO that the royalty is covered by Brand Royalty does not hold any water as there is no co-relation between the two. It was claimed that Brand Royalty is paid for the use of the brand names owned by ‘J&J USA’ whereas the royalty for sales of traded finished goods is paid, apart from manufacturing rights; on the know how relating to sale, distribution and marketing. Therefore, it is incorrect to say that this royalty is included in brand royalty.]
3. T echnical know-how royalty
It is already held that the payment of royalty has to be considered in the light of the agreement between the assessee and ‘J&J USA’, for the same reasons. There is no reason to interfere with the findings of the CIT(A).
4. Corresponding taxes and research and development (R&D) cess on technical know-how royalty
The Ld. CIT(A) has confirmed the decision of the TPO holding that withholding tax and R&D Cess can be allowed only to the extent they are payable on allowable royalty. As it is already held elsewhere that royalty payments have been approved by the RBI and therefore, deserves to be allowed. Accordingly as the payments have been made in the light of the agreement with J&J US and as per the approval/guidelines of the RBI, there is no reason to disallow the tax and R&D Cess paid on technical royalty, and accordingly the AO is directed to delete the addition made on this account.
Section 92C read with Section 37(1)
Where, the assessee, who carries on a business finds that it is commercially expedient to incur certain expenditure directly or indirectly, it would be open to such an assessee to do so notwithstanding the fact that a formal deed does not precede the incurring of such expenditure.
Facts II:
The assessee had entered into a brand usage royalty agreement with its AE on 14-03-2002.
The TPO had held that the brand usage royalty paid by assessee was at arm’s length price.
However, the CIT(A) disallowed the brand royalty paid during the period 01-07-2001 to 14-03-2002 on the ground that there was no agreement in place during the said period indicating the intention to pay royalty with effect from 01-07-2001.
On appeal before the Tribunal, it was mentioned that the assessee had submitted a draft agreement alongwith the application to RBI on 10.8.2001 and thus the royalty was paid as per the guidelines issued by the RBI,
Held II:
The agreement for payment of brand usage royalty was entered into only on 14-03-2002. However, at the same time, the CIT(A) has erred in ignoring the copy of draft brand usage royalty agreement which was submitted by the assessee alongwith application to the RBI on 10-08-2001. The assessee received approval from the RBI on 20-11- 2001 and after receiving the approval from the RBI, the assessee entered into brand usage royalty agreement with ‘J&J US’ by which it was agreed to pay the royalty from 01-07-2001. The date being the same, as agreed in the draft agreement filed with the application made to the RBI, therefore, the observations made by the CIT(A) that there was no tacit agreement does not hold any water.
Assuming, yet not accepting, that there was no agreement, the payments made having regard to the commercial expediency need not necessarily have their origin in contractual obligations. If the assessee, which carries on a business finds that it is commercially expedient to incur certain expenditure directly or indirectly, it would be open to such an assessee to do so notwithstanding the fact that a formal deed does not precede the incurring of such expenditure.
Considering the facts in totality there is no merit in the enhancement made by the CIT(A). The findings of the CIT(A) are set aside. The AO is directed to delete the addition made by the CIT(A).
