Section 92C, the Act – Since the Taxpayer had paid royalty fully and exclusively in course of business and even after paying the same, had earned gross profit at rate better than that earned by comparables, royalty payment was at arm’s length and addition was to be deleted.

Section 92C, the Act – Since the Taxpayer had paid royalty fully and exclusively in course of business and even after paying the same, had earned gross profit at rate better than that earned by comparables, royalty payment was at arm’s length and addition was to be deleted.

FACTS
The Taxpayer was engaged in the business of designer garments. During the relevant year, the Taxpayer entered into an agreement with its AE in USA for licensing designs from the AE. Under the agreement, the AE was to supply designs, provide technical know-how, permit use of logo, provide guidelines and expertise through visits of its personnel and access to the market. In consideration, the Taxpayer paid royalty @ 5% of sales of products.

The Taxpayer benchmarked its major international transaction of sale of garments on cost plus method. It earned gross profit of 19% whereas the comparables had earned between 12% to 16%. The Taxpayer considered that the transaction was at ALP since it had earned better net margins as compared to the comparables.

TPO disallowed royalty on the ground that the Taxpayer was a limited risk contract manufacturer. He thus held that payment of royalty did not conform to arm’s length principle. On appeal, the CIT(A) held that the royalty payment was included in the sale price of garments to its AE. Hence, it was automatically benchmarked. Further, since royalty and export transactions were clubbed to arrive at the gross profit margin, which was higher than the comparables, automatically each of the transactions was to be treated as being carried on at ALP.

HELD

• The royalty paid by the Taxpayer was fully and exclusively incurred in the regular course of business. Even after paying royalty, the Taxpayer earned gross profit @19% which was better than GP of 12% to 16% in case of comparables.

• Therefore, royalty payment was at arm’s length. The addition made by the AO was not justified and was rightly deleted by CIT(A).