The Delhi High Court held that the taxpayer’s payment of an export commission to a related party in Japan cannot be construed as payment of royalty, given there were two distinct and independent agreements for the payment of a royalty and of an export commission.
The High Court rejected the tax department's position that the export commission was a mere monetisation of a “negative covenant” under the royalty agreement—one that prevented the taxpayer from exporting outside India and, thus as the tax department asserted, was tantamount to the payment of a royalty. The High Court also rejected the tax department's contention that the export commission agreement was simply a device to enable the Japanese related party to avoid paying tax on income earned as a result of the use of its know-how by the taxpayer.
The case is: CIT v. Hero Motocorp Ltd. (ITA 923/2015) (Delhi High Court)
The taxpayer manufactured and sold motorcycles using technology licensed by the Japanese related party.
The taxpayer entered into a license and technical assistance agreement with the Japanese entity, and under this contract, the taxpayer received technical assistance for the manufacture, assembly, and service of the products as well as plans and designs for setting up a plant—for which the taxpayer paid a royalty to the related party.
A separate export agreement was entered into, and under this agreement, the related party consented to allow the taxpayer to export specific models of its products in specific territories in exchange for the payment of an export commission equal to 5% of the FOB value of these exports.
The Transfer Pricing Officer determined that the arm’s length price of the payment of export commission was zero (nil) and reached this finding by applying the comparable uncontrolled price (CUP) method. The Transfer Pricing Officer concluded that the payment of the export commission by the taxpayer to its related party was “unnecessary” because there was no economic benefits to the taxpayer.
A transfer pricing adjustment was proposed and then agreed to by the Assessing Officer. The Dispute Resolution Panel agreed, and the taxpayer filed for judicial review by a tribunal. The tribunal found evidence supporting the taxpayer’s treatment—specifically, that the export commission was neither a royalty nor a fee for technical services.
The tax department appealed to the High Court on the grounds that the export agreement was designed to benefit the subsidiaries of the related party—and not the taxpayer.
The High Court concluded that the payment of the export commission was not without consideration because it permitted the taxpayer to make export sales in the specified countries, thereby generating substantial profits, without having to pay for using the existing distribution and sales networks in those territories. The High Court upheld the tribunal’s decision and concluded that the payment of the export commission by the taxpayer to the related party was not in the nature of payment of royalty or fee for technical services.
Read a May 2017 report [PDF 351 KB] prepared by the KPMG member firm in India
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